May 2016

IMF Country Report No. 16/131

COSTA RICA
2016 ARTICLE IV CONSULTATION—PRESS RELEASE;
STAFF REPORT; AND STATEMENT BY THE EXECUTIVE
DIRECTOR FOR COSTA RICA

Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions
with members, usually every year. In the context of the 2016 Article IV consultation with
Costa Rica, the following documents have been released and are included in this package:

 A Press Release summarizing the views of the Executive Board as expressed during its

May 16, 2016 consideration of the staff report that concluded the Article IV
consultation with Costa Rica.

 The Staff Report prepared by a staff team of the IMF for the Executive Board’s

consideration on May 16, 2016, following discussions that ended on March 7, 2016,
with the officials of Costa Rica on economic developments and policies. Based on
information available at the time of these discussions, the staff report was completed
on April 20, 2016.

 An Informational Annex prepared by the IMF staff.

 A Debt Sustainability Analysis prepared by the staffs of the IMF and the World Bank.

 A Statement by the Executive Director for Costa Rica.

The documents listed below have been or will be separately released.

Selected Issues and Analytical Notes

The IMF’s transparency policy allows for the deletion of market-sensitive information and
premature disclosure of the authorities’ policy intentions in published staff reports and
other documents.

Copies of this report are available to the public from

International Monetary Fund  Publication Services

PO Box 92780  Washington, D.C. 20090

Telephone: (202) 623-7430  Fax: (202) 623-7201

E-mail: publications@imf.org Web: http://www.imf.org

Price: $18.00 per printed copy

International Monetary Fund

Washington, D.C.

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Press Release No. 16/229
FOR IMMEDIATE RELEASE
May 19, 2016

International Monetary Fund
700 19th Street, NW
Washington, D. C. 20431 USA

IMF Executive Board Concludes Article IV Consultation with Costa Rica

On May 16, 2016, the Executive Board of the International Monetary Fund (IMF) concluded the
Article IV consultation1 with Costa Rica.

Background

Costa Rica bounced back quickly from the 2008–09 global crisis, but growth, despite picking up

in the last two years to 3.75 percent, has stayed below trend, while macro vulnerabilities, mainly

from the weak fiscal position, have risen. Failure to reverse the counter-cyclical budgetary

stimulus imparted in 2009, and a rising interest bill since then have pushed the deficit to about 6

percent of GDP in 2015–16. This has placed the public-debt-to-GDP ratio on an unsustainable

path, which is fast approaching levels shown to increase risks of disorderly adjustment for

emerging economies. Inflation, on the other hand, has been on a trend decline, and has turned

negative in 2015, owing largely to lower oil prices. The current account, benefiting from the

positive terms-of trade shock, has shrunk to about 4 percent of GDP and is entirely financed by

Foreign Direct Investment. Continuing fast expansion of dollar-denominated credit, facilitated by

a stable exchange rate, has exacerbated vulnerabilities in the financial sector, rendering further

improvements in regulation and supervision even more important.

Growth is expected to accelerate to 4.25 percent in 2016 supported by the dissipation of the one-

off effects arising from a withdrawal of Intel’s manufacturing operations, further terms-of-trade

improvement, and current accommodative monetary policy stance. The output gap is anticipated

to stabilize in 2016, and then close over the medium term. The baseline scenario contemplates

fiscal consolidation measures of 2.25 percent of GDP over the medium term. The central

1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually
every year. A staff team visits the country, collects economic and financial information, and discusses with officials
the country's economic developments and policies. On return to headquarters, the staff prepares a report, which
forms the basis for discussion by the Executive Board.

INTERNATIONAL MONETARY FUND 1

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government overall deficit would decline moderately to 5.25 percent of GDP and the public debt

ratio would reach almost 55 percent of GDP by 2021. Inflation is expected to return to the center

of the new 2–4 percent target range by end-2016 and hover around that value through 2021,

buttressed by continued prudent monetary policy. The current account deficit should widen

slightly to 4.25 percent of GDP over the medium-term, amid gradual recovery of international

commodity prices.

Risks to the outlook are tilted to the downside. Concerning external factors, in the case of faster

US monetary policy normalization, slightly upside risks prevail, with a positive impact of higher

US growth more than offsetting the negative influence of tighter global financial conditions in

the short run. However, extreme bouts of market volatility could inflict serious damage.

Continued real exchange rate appreciation can negatively affect external competitiveness.

Deeper-than-expected slowdowns in the rest of the world could also hamper Costa Rica’s

growth. On the domestic side, the persistent large fiscal deficits could render the economy

vulnerable to sudden changes in financial market conditions, necessitating an increase of

domestic interest rates, which would weigh on private investment and growth. Financial stability

could be jeopardized by substantial currency depreciation, mainly through higher non-

performing loans.

Executive Board Assessment2

Executive Directors commended Costa Rica’s rapid recovery from the global financial crisis.

However, Directors noted that recent growth rates, while increasing over the last two years, have

moderated below trend and macroeconomic vulnerabilities have increased arising mainly from

the large fiscal deficits and high dollarization. They stressed the importance of a well-calibrated

policy mix and broad political consensus to ensure macroeconomic and financial stability and

support inclusive growth.

Directors welcomed the authorities’ fiscal consolidation strategy focusing both on revenue and

expenditure measures. They took positive note of the plans to increase tax collections, impose

tougher sanctions against evasion, and implement the income tax reform as well as the VAT

reform with targeted support to offset the impact on lower-income households. The planned

reduction in the growth of current expenditures will also be important. Directors supported

2 At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of

Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers

used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.

INTERNATIONAL MONETARY FUND

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phased adjustment over the medium term with significant frontloading to balance the objectives

of maintaining growth and lending credibility to the adjustment effort. They emphasized that full

implementation of the planned fiscal reforms will be critical to reducing the large budget deficit

and stabilize the level of public debt over the medium term.

Directors viewed the current expansionary monetary policy stance to be appropriate and

commended the progress made toward the inflation targeting regime. Welcoming the removal of

the exchange rate band, they highlighted that gradual steps towards greater exchange rate

flexibility would strengthen the credibility of the inflation-targeting framework and protect

against shocks. Directors also saw merit in deepening of the foreign exchange market, thereby

facilitating greater exchange rate flexibility.

Directors noted that while the financial system is sound, regulatory upgrades aimed at reducing

dollarization and strengthening supervision will be important going forward. They encouraged

the authorities to fully implement the 2008 FSAP recommendations, gradually adopt Basel III

standards, and improve cross-border supervision. Directors observed that greater competition

between public and private banks would help lower interest rate spreads and foster further

financial deepening.

Directors called for stronger emphasis on structural reforms to boost Costa Rica’s growth

potential and competitiveness. They encouraged greater private sector participation in the energy

sector, along with a review of the tariff-setting framework, and infrastructure upgrades, notably

to ease transportation bottlenecks. They saw scope for efficiency gains and improvement in

educational outcomes. Directors stressed that more efficient education and social spending would

especially benefit the most vulnerable segments of the population and foster more inclusive

growth.

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Table 1. Costa Rica: Selected Social and Economic Indicators, Baseline Scenario 1/ 2/

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Population (2014, millions)4.8 Human Development Index Rank (2013)68 (out of 187)Per capita GDP (2014, U.S. dollars)10,425 Life expectancy (2013, years)80.0Unemployment (2014, percent of labor force)9.7 Literacy rate (2014, percent of people ages > 15)98.0Poverty (2014, percent of population)22.0 Ratio of girls to boys in primary and secondaryIncome share held by highest 10 percent of households39.4 education (2013, percent)103.0Income share held by lowest 10 percent of households1.7 Gini coefficient (2012)48.6Est.201220132014201520162017Output and PricesReal GDP growth5.21.83.03.74.24.3Output gap (percent of potential GDP)2.80.4-0.8-1.1-0.9-0.6GDP deflator3.94.24.72.23.43.2Consumer prices (end of period) 4.63.75.1-0.83.03.0Money and CreditMonetary base16.910.210.49.29.19.0Broad money10.77.715.46.68.68.3Credit to private sector 13.412.217.511.812.112.0Monetary policy rate (percent; end of period)5.03.85.32.3……Savings and InvestmentGross domestic investment 20.518.819.619.119.119.3Gross domestic savings15.313.814.915.114.915.0External SectorCurrent account balance -5.2-5.0-4.7-4.0-4.2-4.3 Of which: Trade balance-11.6-11.3-10.5-10.2-10.2-10.4Financial and capital account balance9.56.44.66.25.15.1 Of which: Foreign direct investment4.14.84.04.14.34.3Change in net international reserves (increase -) -2,110-461113-622-500-500Net international reserves (millions of U.S. dollars)6,8577,3317,2117,8348,3348,834Public FinancesCentral government primary balance-2.3-2.8-3.1-3.0-2.4-1.5Central government overall balance-4.5-5.6-6.0-5.8-5.8-5.4Central government debt34.336.039.342.445.047.3Consolidated public sector overall balance 3/-4.5-5.4-5.6-6.0-6.2-5.7Consolidated public sector debt 4/37.642.043.246.047.949.6 Of which: External public debt7.38.910.511.712.212.7Memorandum Item:GDP (US$ billions)46.549.649.652.956.960.8Sources: Central Bank of Costa Rica, Ministry of Finance, and Fund staff estimates.3/ The consolidated public sector balance comprises the central government, decentralized government entities, public enterprises, and the central bank, but excludes the Instituto Costarricense de Electricidad (ICE).4/ The consolidated public debt nets out central government and central bank debt held by the Caja Costarricense del Seguro Social (social security agency) and other entities of the nonfinancial public sector.(Annual percentage change, unless otherwise indicated)(In percent of GDP, unless otherwise indicated)Proj.1/ Includes cuts in transfers of about 0.4 percent of GDP, another 0.2 percent of GDP of expenditure cuts in a 2016 supplementary budget, broadening of the VAT base and higher taxes on sales of vehicles and real estate from the last quarter of 2016, increase in marginal income tax rates on higher-income brackets from 2017, as well as further amendments to the corporate income tax and moderate gains from improved tax administration.2/ Data for 2012-15 reflect new nominal and real GDP data released by the authorities under new statistical standards and new base year 2012. The methodological changes resulted in an upward revision in nominal GDP of about (cid:160)2½ percent in the base year, as a result mainly of a higher share of the rapidly growing services sector. Pending the release of the full new historical GDP series, nominal and real GDP prior to 2012 are staff estimates using new 2012 GDP data by component, and available past growth rates of components under the old standards.

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STAFF REPORT FOR THE 2016 ARTICLE IV CONSULTATION

April 20, 2016

KEY ISSUES

Context. Growth moderated to below trend in 2013–15. In 2015, the output gap

widened notwithstanding the modest pick-up in growth to 3¾ percent. GDP is expected

to return to potential over the medium-term. Inflation dove into negative territory

following the sharp decline in imported oil prices, but is projected to return to the 2-

4 percent target range by end-2016. The exchange rate (XR) remained stable despite the

removal of the band, and reserve accumulation resumed strongly. Risks to the outlook

are tilted to the downside, notably from large fiscal deficits and high dollarization.

The short-term policy mix should be characterized by the start of fiscal tightening

and continuation of a supportive monetary policy. The authorities appropriately

intend to begin gradual fiscal adjustment in 2016 to reduce the sustainability gap,

though most of the measures require approval by the opposition-controlled Congress.

The tighter fiscal stance and cyclical conditions call for a continued accommodative

monetary policy, consistent with bringing inflation back to the target range.

Steady fiscal consolidation is required over the medium term. The authorities’ fiscal

plan, which contemplates somewhat front-loaded consolidation followed by more

gradual adjustment, is appropriate to bring public debt on a sustainable footing, while

maintaining robust growth. Swift adoption of fiscal reforms submitted to Congress and

administratively-determined spending cuts is critical to achieve these objectives.

It is important to strengthen the monetary policy framework. Higher XR flexibility is

useful to complete the transition to inflation targeting. It would be facilitated by FX

market deepening. Fostering the secondary government bond market would also help.

Further improvements in financial system regulation and supervision, as well as

structural reforms to stimulate inclusive long-term growth, are also needed.

Additional regulatory upgrades may be necessary if recently adopted measures do not

succeed in reversing the trend toward increased credit dollarization. Efforts should be

undertaken to bolster consolidated and cross-border supervision, strengthen

creditworthiness assessments, implement pending 2008 FSAP recommendations, and

gradually adopt Basel III standards. Steps to boost potential growth include easing

infrastructure and regulatory bottlenecks, increasing efficiency of education and social

spending, and improving the financial architecture.

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Approved By
K. Srinivasan (WHD)
and M. Miyazaki
(SPR)

CONTENTS

Discussions took place in San Jose during February 23–March 7,
2016. The mission comprised L. Figliuoli (Head), V. Flamini, F.
Lambert, D. Plotnikov, and J. Puig.

OVERVIEW ________________________________________________________________________________________ 4

RECENT ECONOMIC DEVELOPMENTS AND OUTLOOK ________________________________________ 4
A. Recent Developments ___________________________________________________________________________4
B. Macroeconomic Outlook and Risks ____________________________________________________________ 10

POLICY DISCUSSIONS __________________________________________________________________________ 15
A. Near-term Policy Mix __________________________________________________________________________ 15
B. Safeguarding Fiscal Sustainability _____________________________________________________________ 17
C. Improving the Monetary and Exchange Rate Policy Framework _______________________________ 20
D. Financial Stability ______________________________________________________________________________ 21
E. Structural Reforms _____________________________________________________________________________ 26

STAFF APPRAISAL ______________________________________________________________________________ 27

BOX
1. External Stability Assessment __________________________________________________________________ 30

FIGURES
1. Stress Test Results _____________________________________________________________________________ 25
2. Recent Developments and Prospects, Real Sector _____________________________________________ 32
3. Recent Developments, External Sector_________________________________________________________ 33
4. Recent Developments and Prospects, Fiscal Sector ____________________________________________ 34
5. Recent Developments, Financial Sector ________________________________________________________ 35
6. Financial Sector Vulnerabilities ________________________________________________________________ 36
7. Competitiveness and Structural Reforms ______________________________________________________ 37

TABLES
1a. Selected Social and Economic Indicators, Baseline Scenario _________________________________ 38
1b. Selected Social and Economic Indicators, Full Fiscal Adjustment Scenario ___________________ 39
2. Balance of Payments, Baseline Scenario (Partial Fiscal Adjustment) ___________________________ 40

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3a. Central Government Balance, Baseline Scenario (Partial Adjustment) ________________________ 41
3b. Central Government Balance, Full Fiscal Adjustment Scenario _______________________________ 42
4a. Summary Operations of the Central Government, GFSM 2001 Classification. Baseline
Scenario (Partial Adjustment) ____________________________________________________________________ 43
4b. Summary Operations of the Central Government, GFSM 2001 Classification. Full Fiscal
Adjustment Scenario _____________________________________________________________________________ 44
5a. Consolidated Public Sector Operations, Baseline Scenario ___________________________________ 45
5b. Consolidated Public Sector Operations, Full Fiscal Adjustment Scenario _____________________ 46
6a. Summary Operations of the Consolidated Public Sector, GFSM 2001 Classification. Baseline
Scenario (Partial Adjustment) ____________________________________________________________________ 47
6b. Summary Operations of the Consolidated Public Sector, GFSM 2001 Classification.
Full Fiscal Adjustment Scenario __________________________________________________________________ 48
7. Public Sector Debt, Baseline Scenario _________________________________________________________ 49
8. Monetary Survey, Baseline Scenario (Partial Adjustment) ______________________________________ 50
9a. Medium-Term Framework, Baseline Scenario (Partial Adjustment) ___________________________ 51
9b. Medium-Term Framework, Full Fiscal Adjustment Scenario __________________________________ 52
10. Banking Sector Indicators ____________________________________________________________________ 53

ANNEXES
I. Financial System Assessment Program (FSAP) Main ____________________________________________ 54
II. Summary of Recommendations in the WHD Cluster Surveillance _____________________________ 56
III. Public Debt Sustainability Analysis ____________________________________________________________ 57
IV. External Debt Sustainability Analysis __________________________________________________________ 66

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OVERVIEW

Having bounced back quickly from the global crisis, growth has moderated below

trend and macro vulnerabilities, mainly from the weak fiscal position, are rising. After falling

modestly in 2009, real GDP surged in 2010–12. Since then, however, growth has remained below

potential, with the latter also declining. Hence, structural impediments must be removed to maintain

sustained rates of economic expansion. The counter-cyclical budgetary stimulus imparted in 2009

pushed the deficit above 5 percent of GDP in 2010 (mainly through a rise in wages and transfers).

The deficit has crept up further to 6 percent since then, placing the public-debt-to-GDP ratio on an

unsustainable upward trajectory and fast approaching levels associated with higher risks of

disorderly adjustment in emerging economies. Continuing fast expansion of dollar-denominated

credit, facilitated by a stable XR, exacerbates vulnerabilities in the financial sector, rendering further

improvements in regulation and supervision even more important.

Policy actions have been broadly consistent with past Fund advice. The authorities

submitted to Congress a fiscal reform package that is in line with staff advice, though its approval

will require cooperation of opposition parties (¶22). Other measures consistent with past Fund

advice include: (i) the removal of the XR band in early 2015 and continued reserve accumulation (¶5),

(ii) the reduction in the inflation target range in 2016 to 2–4 percent, in line with the average

inflation of trading partners (¶4), and (iii) tightening of prudential requirements to discourage

dollarization (¶28). The large easing of monetary policy was an appropriate response to the

unexpectedly sharp decline in headline and core inflation amid low international oil prices (¶4).

Additional progress is needed to implement the 2008 FSAP recommendations (¶29).

RECENT ECONOMIC DEVELOPMENTS AND OUTLOOK

A. Recent Developments

A third year of growth below potential has resulted in a moderate output gap. Having

expanded by almost 5 percent annually in 2010–2012, growth slowed to 2½ percent in 2013–14.

This reflected both gradual weakening of

domestic demand following the rebound from

the 2008–09 crisis as well as sluggish export

growth, the latter mirroring the pace of the U.S.

recovery. Growth picked up to 3¾ percent in

2015, as the boost to domestic demand from

improved terms of trade, associated with lower

commodity prices, and higher investment more

than offset the drag from Intel manufacturing’s

closure, adverse weather conditions for the

main agricultural export crops, and slightly

contractionary financial conditions—the latter

reflecting higher real lending rates and real

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-2-10123456789200720082009201020112012201320142015 Output gap Real growth Potential growthGDP growth, Potential and Output Gap(Percent)Sources: National authorities, and IMF staff estimates

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appreciation (¶9). Nevertheless, both private and public investment recovered significantly, the latter

supported by construction of a new port terminal and public water systems. Overall, with growth

below its trend rate of 4 percent during 2013-15, a negative output gap of about 1 percent of GDP
has opened up (Analytical Note (AN) VIII).1 The unemployment rate has been elevated since the
crisis; its slight decline in 2015 was mainly due to lower participation from discouraged workers.

The central bank took advantage of the favorable shock from lower oil prices to

reduce its inflation target range. Inflation increased sharply and breached its upper limit in 2014,

owing mostly to the pass-through to domestic prices from XR depreciation in early 2014. The breach

was short-lived, though, as the sharp decline in imported oil prices, tight monetary policy, and a

widening output gap drove inflation into negative territory by the second half of 2015. The central

bank reacted by cutting the policy rate by 350 basis points to 1¾ percent. It also availed itself of the

propitious circumstances—with inflation projected to stay below the 3–5 target range until the end

of 2016 and inflation expectations falling for the first time below the center of the range—to lower

the target to 2–4 percent, in line with average inflation of trading partners.

The exchange rate has been stable despite abandonment of the band regime, and

reserve accumulation has resumed strongly. After a short period of heightened volatility in early

2014, amid increased prospects for U.S. monetary policy normalization, the XR quickly stabilized

again about 6–7 percent above the floor of the XR band, and remained there despite the early-2015

removal of the band, in line with Fund advice to strengthen the inflation targeting framework. A

lower current account deficit—4 percent of GDP in 2015, driven by lower oil prices—as well as

continued government Eurobond issuance, resilient FDI flows, and increased net foreign bank

liabilities to meet renewed demand for credit in FX resulted in continued strong foreign reserve

accumulation, in line with the authorities FX purchase program, to $7.8 bn at end-2015, above the

1 Intel’s closure resulted in both lower real GDP and lower potential output of ¾ percent of GDP in 2014-15, without
any effect on the output gap in the short run.

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-404812162024Feb-08Aug-08Feb-09Aug-09Feb-10Aug-10Feb-11Aug-11Feb-12Aug-12Feb-13Aug-13Feb-14Aug-14Feb-15Aug-15Feb-16 Target band Headline inflation Inflation expectations (12-months) Core inflationHeadline Inflation(Percent, y-o-y)Sources: Haver, BCCR and Fundstaff calculations.

-50510152025Feb-08Aug-08Feb-09Aug-09Feb-10Aug-10Feb-11Aug-11Feb-12Aug-12Feb-13Aug-13Feb-14Aug-14Feb-15Aug-15Feb-16 Others Food Electricity, Gas and Fuel IndexCosta Rica: Inflation Decomposition(Contribution to growth y/y, in percent)Sources: Haver analytics and Fund staff estimates.

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IMF adequacy metrics.2 Nonetheless, in December 2015 and early 2016, reserves declined
somewhat, as FX demand, including by financial intermediaries, increased and the central bank

accommodated it, resulting in a flat XR.

The external position is close to equilibrium, with competitiveness largely unchanged

in 2014–15. In the first half of 2014, a third of the 30 percent real effective exchange rate (REER)

appreciation accumulated over the last decade was undone, as nominal colón depreciation

outpaced a growing inflation differential. Since then, however, the REER rose steadily until stabilizing

about 5 percent above its end-2013 level. At the same time, this increase is consistent with the

change in the REER equilibrium value and, as a result, competitiveness has not deteriorated (Box 1).

In particular, multilaterally consistent estimates under the EBA and other regression-based

approaches support this view. Nevertheless, productivity-enhancing reforms (¶32) and wage

restraint are needed to maintain Costa Rica’s competitiveness in world markets. Fiscal consolidation

(¶18-23) would also buttress long-term external stability.

External Sustainability Assessment

Failure to reverse the countercyclical fiscal policies implemented during the global

financial crisis put public debt on a rapid

upward trend. Attempts to curb government

outlays, mainly through capital expenditure cuts in

2011, were undermined by the rising transfers (to

decentralized public entities) and interest bill in

2012–2013. Tax collections, after falling from pre-

crisis levels that were boosted by GDP growth well

above trend, remained stagnant, with a revenue-

enhancing tax reform nullified by the Constitutional

Court owing to procedural irregularities in 2012.

Consequently, the central government (CG) primary

deficit returned to its crisis peak of around 3 percent of GDP in 2013. The new administration that

came into power in mid-2014 maintained a broadly unchanged non-interest deficit, as efforts to

2 After a substantial decline in 2014 reflecting in part the end of reinvestment of retained earnings by Intel, FDI
remained steady in 2015, suggesting limited impact of the exit on broader FDI trends.

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Regression-based methodsCA normCA projected/ cyclically-adjustedREER gap (updated)REER gap (2014 AIV)REER gap (2012 AIV) Macroeconomic Balance-3.2-3.91.9-0.87.9 External sustainability (ES)-2.4-4.56.813.28.5 ES (NFA exclud. FDI)-7.2-4.5-7.1-5.9NAEBA Macroeconomic Balance-4.7-3.9-2.1-4.78.5Average-0.10.59.9Sources: Fund staff estimates.Costa Rica: Implied Undervaluation ("+" = Overvaluation)

01020304050-8-6-4-20246200720082009201020112012201320142015 Debt (rhs) Overall balance Primary balanceCentral Government(Percent of GDP)Sources: National authorities and Fund staff estimates.

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restrain spending and reduce tax evasion prevented a budgeted deterioration in the primary

balance of more than ½ percent of GDP in 2014–15. Meanwhile, a rising interest bill has lifted the

overall CG deficit to 6 percent of GDP in 2014-15, with debt exceeding 42 percent of GDP in 2015.

Though the impact on domestic financing costs has been muted by the annual $1 bn external bond

issuance since 2012 and aggressive monetary easing in 2015, spreads on external bonds have
doubled since the 2013 tapering tantrum and the country lost its investment grade in 2014.3

The authorities have developed a strategy for fiscal consolidation focused on

strengthening revenue. The new government initially formulated a consolidation proposal focused

on reducing tax evasion and a few exemptions. Since then, a more comprehensive plan, that is

broadly consistent with staff recommendations both in its size and its emphasis on revenue

enhancements through tax base widening and higher rates, has been developed (¶21).

Potential Output Growth and Output Gap Estimates

(In percent)

The recent loosening of monetary policy is expected to bring about financial

conditions more supportive of growth. Real lending rates have been edging upwards since mid-

3 Moody’s downgraded Costa Rica’s external sovereign debt by one notch in 2014 with a negative outlook on its
current Ba1 rating. S&P downgraded the sovereign by one notch to BB- in 2016, while Fitch has a negative outlook
on its BB+ rating since 2015.

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2000-082009-14201520142015Production Function 4.603.783.950.25-0.36Cycle Extraction FiltersHodrick-Prescott4.603.743.850.46-0.06Butterworth4.523.663.780.490.03Christiano-Fitzgerald4.533.523.990.42-0.24Baxter-King5.233.763.800.16-0.31Univariate Kalman FiltersDeterministic Drift4.114.114.110.43-0.33Mean Reversion4.514.604.60-0.40-1.15Multivariate Kalman FilterWith inflation4.783.783.64-0.02-0.34Average of All Models4.613.873.970.22-0.35Macroframework 2/4.794.004.00-0.43-1.11Source: Fund staff estimates.Potential GDP growth rateOutput Gap 1/1/ Includes level effect on potential output of Intel exit, estimated at 0.2 percent of GDP in 2014 and 0.8 percent in 2015. 2/ The output gap in the macroeconomic framework is slightly different from model-based estimates, as the level of potential output for each past year in the historical series reflects the estimate available at the time.

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2014, as limited transmission of the large policy rate cuts to lending rates thus far has been more

than offset by the fall in inflation expectations. In addition, the REER has resumed its appreciating

trend and credit growth has moderated. A broad-based index (FCI) developed by staff (featuring the

influence on economic activity of credit, deposits, real interest rates, REER, and house prices)

suggests that financial conditions were slightly contractionary in 2015, owing to higher real interest

rates and real appreciation (AN III). However, this is likely to be reversed as the lower policy rates

gradually complete their pass-through. Monetary transmission, though, is hamstrung by high

dollarization, segmentation of the banking system, limited capital market development (¶33 and

AN V), and anticipation of forthcoming upward pressures on interest rates from large budgetary

financing needs.

10.

The financial system appears sound, though profitability is low and dollarization

continues to be a source of vulnerability. Bank capital is well above regulatory requirements and

liquidity indicators are robust. While non-performing loans have remained low, profitability has

declined slightly in recent years, and remains below that of regional peers. Reliance on foreign

funding has continued to increase, although staff analysis suggests that associated rollover risks

remain manageable even under scenarios of extreme shocks in international banking systems.

Moreover, macroeconomic trends are consistent with recent and anticipated credit growth and

there is little evidence of financial sector risk buildup (ANs I and II). Indeed, while the depth of Costa

Rica’s financial system improved considerably in the past decade, it continues to lag those of

comparable emerging markets as well as the degree of development implied by its macroeconomic

fundamentals. In particular, credit to the private sector is still well below the estimated level

consistent with fundamentals (ANs IV and V). Amid renewed exchange rate stability since late 2014,

however, credit growth has again tilted toward FX, including to sectors without natural FX hedges,

despite already high levels of bank loan dollarization.

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Costa Rica. Financial Soundness Indicator Heat Map

Sources: BIS; FSIs; IMF IFS; and national authorities.

INTERNATIONAL MONETARY FUND

-20-100102030405060Feb-05Feb-06Feb-07Feb-08Feb-09Feb-10Feb-11Feb-12Feb-13Feb-14Feb-15Feb-16 Total In domestic currency In foreign currencyPrivate Sector Credit Growth by Currency (Percent, y-o-y)Sources: BCCRand Fund staff calculations.

Costa Rica2013Q22013Q32013Q42014Q12014Q22014Q32014Q42015Q12015Q22015Q3Overall Financial Sector RatingLLLMMMMLLLCredit cycleLLLHHMMLLLChange in credit / GDP ratio (pp, annual)1.31.61.95.15.24.74.31.51.72.8Growth of credit / GDP (%, annual)2.73.33.910.510.69.68.42.73.15.2Credit-to-GDP gap (st. dev)1.21.21.41.71.20.80.6-0.1-0.40.6Balance Sheet SoundnessLLLLLLLLLLBalance Sheet Structural RiskMMMMMMMMMMDeposit-to-loan ratio113.7110.8107.5105.0101.7101.5100.797.297.795.3FX liabilities % (of total liabilities)36.735.433.236.636.935.934.534.635.133.8FX loans % (of total loans)37.337.737.938.738.037.537.036.737.037.2Balance Sheet BuffersLLLLLLLLLLLeverageLLLLLLLLLLLeverage ratio (%)10.110.09.79.89.79.79.710.09.79.9ProfitabilityLLLLLLLLLLROA1.31.11.21.51.31.21.11.11.01.0ROE8.67.57.910.79.58.47.68.07.47.4Asset qualityLLLLLLLLLLNPL ratio1.91.91.71.61.61.71.61.61.61.7NPL ratio change (%, annual)1.24.30.2-10.6-14.9-12.0-11.2-2.00.71.6Memo items:2013Q22013Q32013Q42014Q12014Q22014Q32014Q42015Q12015Q22015Q3Credit-to-GDP (%)48.749.450.853.453.854.155.154.955.556.7Credit-to-GDP gap (%; HP filter)-1.9-1.6-0.61.51.41.11.60.91.0n.a.Credit growth (%; annual)11.111.312.219.019.818.717.511.811.412.2CAR (in %)17.217.216.616.016.316.216.616.616.416.6Tier 1 CAR (in %)13.713.513.012.912.712.612.712.912.612.8

-505101520 GDP growth Investmentgrowth Private cons.growth Inflation Employmentgrowth P10 P25 P75 P90 2016 Forecast Source: IMF staff estimates based on RES MacroFinancial ForecastDistribution of Macro Outcomes Conditional on Real Private Sector Credit Growth

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COSTA RICA

B. Macroeconomic Outlook and Risks

11.

The joint view of staff and the authorities was that the economy will expand faster and

inflation revert to the target range in 2016, with activity returning to potential over the medium

term. Growth is expected to accelerate to 4¼ percent

in 2016, slightly above potential growth, supported

by: (i) dissipation of the one-off effects of Intel’s

manufacturing withdrawal, (ii) further terms-of-trade

improvement from the additional decline in

international oil prices, (iii) domestic monetary

stimulus—model simulations suggest that the

monetary easing implemented in 2015 would boost

GDP growth by ½–¾ percent of GDP in 2016,

assuming full though gradual transmission from

policy to lending rates—and (iv) sustained real credit

expansion (estimated by staff to be consistent with

projected GDP growth based on historical
precedent).4 The output gap is anticipated to stabilize

in 2016, and then mostly close over the medium term. Model simulations also suggest that the monetary

stimulus, together with fading base effects from the oil price decline in 2015, would also bring inflation

back to the center of the new 2–4 percent target range by end-2016. Inflation is then projected to hover

around that value throughout 2017–21, buttressed by continued prudent monetary policy, while still

allowing for continued monetary accommodation during the initial phase of the fiscal adjustment. The

current account deficit will widen slightly to 4¼ percent of GDP over the medium-term, amid gradual

recovery of international commodity prices, while partial fiscal consolidation—focused on revenue

measures that increase the progressivity of the tax system and with some attendant confidence effects—

is not expected to have a significant negative impact on domestic demand. The staff baseline scenario,

which incorporates the measures already submitted to Congress that have a higher probability of being

approved, contemplates fiscal consolidation measures of 2¼ percent of GDP over the medium term. The

CG overall deficit would decline slightly to 5½ percent of GDP and the public debt ratio would reach 55

percent of GDP by 2021 (¶18 and AN VI).

12.

The authorities also concurred that an alternative scenario incorporating the fiscal

adjustment necessary to restore debt sustainability would yield a more favorable outlook.

According to staff analysis, a total correction of about 3¾ percent of GDP would stabilize public debt in

the medium term within “safe levels,” with only moderate short-term output costs (¶19). Growth would

be only slightly lower in initial years and higher in outer years than in the baseline case. This is not only

because of significant confidence effects but also of the more balanced macro policy mix allowed by

tighter budgets consistent with restoring fiscal sustainability and reducing the current account deficit.

4 The effect of Intel’s manufacturing closure on the growth rate of potential GDP is estimated to be less than
¼ percentage points. The withdrawal is not expected to have significant impact on fiscal revenue as Intel operated in
the free trade zone.

INTERNATIONAL MONETARY FUND

-0.4-0.200.20.40.60.812015201620172018201920202021 CPI inflation CPI inflation - SPPT Real GDP Real GDP - SPPTReal Effect of a 300bp Policy Rate Cuts with Different PT(Percent difference from baseline)Sources: IMF staff calculation based on RES FSGMNote: PT=Pass-through to Lending Rates; SPPT=Slower, morepersistent PT (1/3)

Page 16

Indeed, a looser monetary stance than in the baseline would be sufficient to achieve the inflation target

over the medium-term, thereby also mitigating increases in market rates associated with the

normalization of U.S. monetary policy.

Costa Rica: Baseline Scenario, Partial Fiscal Adjustment 1/

COSTA RICA

Costa Rica: Full Fiscal Adjustment Scenario 1/

13.

The authorities agreed that risks to the outlook were tilted to the downside. Downside

risks stem from both global uncertainties and weaknesses in domestic fundamentals (as detailed in

the Risk Assessment Matrix):



External risks. The normalization of U.S. monetary policy presents moderately upside risks.

Absent pronounced increases in market volatility, faster U.S. growth would have a positive

impact on Costa Rican GDP, given strong trade ties, more than offsetting the negative

influence of tighter global financial conditions. However, extreme bouts of market volatility—

from a disorderly U.S. monetary policy normalization, stresses in emerging markets with high

corporate leverage (including in FX), or heightened global geopolitical risks—could inflict

INTERNATIONAL MONETARY FUND

(In percent of GDP, unless otherwise indicated)2015 201620172018201920202021Real GDP growth (percent)3.74.24.34.44.34.04.0Output gap (percent of potential GDP)-1.1-0.9-0.6-0.30.00.00.0CPI (percent, end-of-period)-0.83.03.03.03.03.03.0Current account balance -4.0-4.2-4.3-4.2-4.3-4.3-4.3Central government fiscal balance -5.8-5.8-5.4-5.5-5.5-5.5-5.3Structural primary balance -2.9-2.3-1.4-1.1-1.2-1.2-1.2Structural overall balance -5.7-5.6-5.3-5.4-5.5-5.5-5.2Central government debt 42.445.047.349.451.352.954.4Source: Fund staff estimates.1/ The baseline scenario includes fiscal consolidation measures of about 2¼ percent of GDP, partly offset by a projected underlying deterioration in the primary balance mainly driven by the constitutionally mandated increase in education expenditure.

(In percent of GDP, unless otherwise indicated)2015 201620172018201920202021Real GDP growth (percent)3.74.24.24.64.54.24.3Output gap (percent of potential GDP)-1.1-0.9-0.7-0.20.20.30.4CPI (percent, end-of-period)-0.83.03.03.03.03.03.0Current account balance -4.0-4.2-4.2-4.1-4.0-3.8-3.7Central government fiscal balance -5.8-5.7-4.4-3.6-3.6-3.3-3.2Structural primary balance -2.9-2.3-0.80.10.10.20.2Structural overall balance -5.7-5.5-4.2-3.6-3.6-3.4-3.3Central government debt 42.444.946.246.146.045.745.5Source: Fund staff estimates.1/ Includes measures as in the baseline scenario and additional measures of 1½ percent of GDP.

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COSTA RICA

serious damage, especially given Costa Rica’s weak fiscal position, bank reliance on foreign

funding, and domestic credit dollarization, with associated exposures to interest rate and

exchange rate risks, the latter evident only in the event of a large depreciation (¶26 and

AN I). Conversely, if the nominal effective exchange rate of the colón continues to

appreciate in line with the U.S. dollar, competitiveness vis-à-vis other trading partners would

be negatively affected. In addition, deeper-than-expected slowdowns in the rest of the world

could hamper Costa Rica’s growth, both in the short term—as the credit cycle matures in key

emerging markets—and in the medium term, reflecting structurally weaker growth in

advanced countries that have not fully addressed crisis legacies. At the same time, model

simulations of the effect of slowdowns in foreign demand suggest that Costa Rica is less

vulnerable to adverse developments in key emerging markets, including China and Brazil,

than in the U.S., consistent with relative trade ties (AN VIII). In addition, the fact that Costa

Rica does not have a significant offshore sector like other countries in the Central America-

Caribbean region, and given also comparatively limited anti-money-laundering-compliance

concerns (¶31), the country appears less vulnerable to de-risking strategies by global banks,
including loss of correspondent banking services.5 Risks from energy prices are balanced,
with increased volatility possibly deriving from geopolitical tensions weighing on the

downside, while lower-than-anticipated prices would have moderately positive effects.

Real and Financial Spillovers

5 The authorities and the financial community confirmed that any requests for additional information on AML/CFT
procedures and readiness from correspondent banks had been satisfactorily met and that there had not been any
loss of correspondent accounts. Moreover, domestic banks had remained active in monitoring possible AML/CFT
activity, as demonstrated by a recent case currently under investigation raised by one of the public banks.

INTERNATIONAL MONETARY FUND

-0.6-0.4-0.20.00.20.40.60.8201620172018201920202021 S1: USMP normalization + Higher EM riskpremium S1 + CRI fiscal consolidationCosta Rica: GDP(Percent deviation from baseline)Source: Staff estimates. Note: While domestic fiscal consolidation will reduce GDP growth in the short term, a positive confidence effect is assumed to prevail in the medium to long term.

-1.6-1.2-0.8-0.40.00.4Jun-15Sep-15Dec-15Mar-16Jun-16Sep-16Dec-16 US China Germany CA6 BrazilCosta Rica: GDP(Percent deviation from baseline)Source: Staff estimates. Note: Effect of 1 percent lower growth in domestic demand in selected economies.

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COSTA RICA



Domestic risks. The persistence of large fiscal deficits and the ensuing rapid rise in the public

debt ratio in a passive scenario where political support for budget consolidation falls short,

could render the economy vulnerable to sudden changes in financial market conditions.

Also, large government gross financing requirements could lift domestic interest rates,

weighing on private investment and growth. Expectations of a pick-up in interest rates

driven by the government short-term financing needs are already encouraging maintenance

of excess liquidity in banks, which also limits the transmission of the monetary stimulus to

lending rates—model simulations suggest that if pass-through of the policy rate cuts

continued to be hindered by these concerns, the short-term boost to growth from monetary

stimulus would be reduced by half (¶11 and AN I). Given low profitability and heavy

dollarization of the banking system, financial stability could also be jeopardized by

substantial currency depreciation, mainly through higher NPLs (¶26, AN I and II).

Costa Rica: Passive Scenario 1/

INTERNATIONAL MONETARY FUND

(In percent of GDP, unless otherwise indicated)2015 201620172018201920202021Real GDP growth (percent)3.74.24.24.03.93.63.5Output gap (percent of potential GDP)-1.1-0.9-0.6-0.6-0.7-1.1-1.6CPI (percent, end-of-period)-0.83.33.53.53.53.53.5Current account balance -4.0-4.5-5.0-5.8-6.5-6.5-6.5Central government fiscal balance -5.8-6.7-7.3-7.8-8.5-9.2-9.6Structural primary balance -2.9-3.1-3.3-3.3-3.4-3.4-3.4Structural overall balance -5.7-6.6-7.2-7.6-8.4-9.0-9.3Central government debt 42.445.950.154.459.164.069.1Source: Fund staff estimates.1/ This scenario does not include any fiscal consolidation measures, while reflecting the underlying deterioration in the primary balance mainly driven by the constitutionally mandated increase in education expenditure.

2. Inward spilloverrisks3. Credit risks4. Market andliquidity risks5. Monetary andfinancial conditions6. Risk appetite1. Macroeconomicrisks0246810 2014Q2 2015Q3Source: Fund staff estimates.Costa Rica: Financial Stability Map

-14-12-10-8-6-4-202015201620172018201920202021 Real investment Real GDP Real consumptionReal Effect of a 100bp Increase in Market Interest Rates(Percent difference from control)Sources: IMF staff calculation based on RES FSGM

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COSTA RICA

Source of Risks

1. Slower growth in
advanced and/or
emerging economies.

2. Tighter or more
volatile global
financial conditions,

Costa Rica: Risk Assessment Matrix

Overall Level of Concern (Scale—high, medium, or low)

Relative Likelihood2

Impact if Realized

Low/Medium/High

Medium/High

 Sharper-than-expected global slowdown in the short-
term, triggered by significant China slowdown (Low in
the short-term, Medium thereafter), or turning credit
cycle in EMs (Medium).

 Protracted period of slower growth in advanced (High)

and emerging economies (Medium) would reduce
growth in Costa Rica, in particular, if growth in the U.S.
is negatively affected.

 Impact of weaker emerging markets growth in the short-
or long-term would be moderate, as long as U.S. growth
was relatively unaffected (Medium).

 Protracted period of weaker-than-expected growth in
the U.S. would lower export demand and significantly
weigh on activity and tax revenues. A shock could have a
more severe impact than in 2008-09, as fiscal buffers
have been drawn down (High).

 Surges in global financial market volatility—triggered

 While orderly UMP exit with stronger U.S. growth in

Medium/High

High/Medium

by geopolitical tensions, or revised market
expectations on UMP exit/emerging market
fundamentals—would reduce capital flows to Costa
Rica, lead to an increase in cost of government
financing, as well as potentially an increase in cost of
funding for the private sector (Medium).

 Surge in U.S dollar prompted by improving U.S.

economic prospects versus the rest of the world (High).

tandem with higher U.S. rates would on net be beneficial
for Costa Rica, a decline in capital flows to emerging
markets under more disorderly scenarios could disrupt
foreign credit lines and reduce banking sector liquidity. If
markets reassess more negatively fiscal risks in Costa
Rica, the cost of external government and private sector
financing could increase sharply, negatively affecting
public debt dynamics and growth (High).

 If the NEER continues to appreciate in line with the
dollar, competitiveness vis-à-vis de rest of the world
would be negatively affected. Conversely, if the local
currency depreciated, the private sector (with negative
foreign exchange positions) and banks would be
negatively affected (through higher credit risks on
unhedged borrowers, despite banks’ long FX positions)
(Medium).

3. Dislocation in
capital and labor
flows.

Medium/High

Medium

 Reduced financial services by global/regional

banks, including loss of correspondent banking
services (Medium).

 Increased volatility due to security dislocations in the

Middle East, Africa, and Europe, leading to sharp rise in
oil price volatility (High).

 Could curtail cross-border payments, trade finance, and

remittances.

 Volatile oil prices could result in adverse changes in
terms of trade, increase inflation, and be a drag on
growth.

4. Sustained decline
in energy prices.

High

Low

 The recent fall in oil prices could persist and deepen,

 Persistently low oil prices would improve Costa Rica’s

with supply factors reversing only gradually.

terms of trade and counterbalance inflationary pressures,
potentially yielding a modest boost to growth prospects.

High

5. Worse-than-
anticipated impact
from persistently high
fiscal deficits, or
higher deficits than
projected in the
baseline scenario.

 Lack of fiscal consolidation prospects may hurt

confidence.

 Continued expenditure pressure and lack of tax reform

could increase the fiscal deficit and public debt more
than projected in the baseline scenario, which already
envisages a rapid build-up of public debt.

 Lower confidence or a higher government financing

requirement could raise domestic interest rates further
and reduce investment and growth.

 Lower growth or a higher fiscal deficit would exacerbate

fiscal sustainability risks, increasing the economy’s
vulnerability and reducing the government’s ability to
respond to adverse shocks.

 Alternatively, even if confidence remained strong and
financing were available, a looser fiscal stance could
result in overheating.

INTERNATIONAL MONETARY FUND

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COSTA RICA

Costa Rica: Risk Assessment Matrix (concluded)

6. Larger than
anticipated impact
from INTEL
withdrawal



Low

Low/Medium

INTEL’s withdrawal and external competition weighs
down on FDI and leads to an increase in
unemployment and a reduction in productivity growth
as the enterprises with a more sophisticated export
base close. An unsustainable fiscal position may
exacerbate these risks.

 Depending on the size of the reduction in FDI flows,
there may be low to moderate impact on short-term
growth, due to lower capital accumulation and
productivity growth. The impact on potential growth,
however, is likely to be limited since Costa Rica has
strong institutions and a well-educated workforce.

1 The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path discussed in this report (which is the scenario most
likely to materialize in the view of the staff). The RAM reflects staff's views on the source of risks and overall level of concerns as of the time of
discussions with the authorities. The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding this baseline.
2 In case the baseline does not materialize.

POLICY DISCUSSIONS

14.

Discussions focused on the policy mix appropriate for current cyclical conditions and

mitigation of longer-term economic vulnerabilities. In particular, the latter centered on how to:

(i) restore fiscal sustainability; (ii) improve the monetary policy framework; (iii) further enhance

financial system supervision and regulation; and (iv) boost potential and inclusive growth.

A. Near-term Policy Mix

15.

There was agreement that economic conditions call for a policy mix characterized by

the start of fiscal tightening and continuation of a supportive monetary policy. The authorities

appropriately intend to begin a gradual fiscal adjustment in 2016 (¶s16, 20). With output below

potential and zero inflation, a continued accommodative monetary policy stance consistent with

bringing inflation back to the target range will help offset the small contractionary impact of the

tighter budgetary stance in the short term.

16.
Indeed, the authorities are pursuing a sizable reduction in the deficit in 2016 as part
of a gradual path toward fiscal sustainability. Although the 2016 budget6 envisaged the overall
and primary deficits to edge up to 6½ and 3¼ percent of GDP respectively in a passive scenario, as

a result mainly of constitutionally-mandated rises in education outlays and continued increases in

interest payments, the government has submitted to Congress bills that could result in a correction

of about ¾ percent of GDP relative to the budget. In staff’s view, this correction, as part of a policy

mix that takes into account the cyclical position of the economy (¶20), would be suitable. Officials

were also adamant that it will be critical to implement these measures as part of a comprehensive

package that delivers the total budgetary consolidation measures of 3¾ percent of GDP needed to

stabilize debt over the medium-term (¶s19 and 20 ).

6 Adjusted for targets in the medium-term framework (published together with the budget law) that have generally
been more aligned with the authorities’ intended fiscal stance.

INTERNATIONAL MONETARY FUND

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COSTA RICA

17.

The authorities concurred that the current expansionary monetary stance is broadly

adequate. Headline inflation was negative and core inflation was below the lower bound of the 3-5

percent target range during most of 2015. Inflation is projected to return to the center of the new 2-

4 percent target range by end-2016, while output remains below potential. Thus, the monetary

stance—with 350 basis points in

cumulative policy rate cuts to 1¾

percent, well below the estimated

neutral rate of 5 percent—is

appropriately expansionary (AN III).

While transmission of the stimulus

has been slow (¶9), domestic financial

conditions are expected to gradually

reflect the monetary easing, which,

together with continued credit

growth at a pace consistent with

healthy financial deepening, should

support the return of economic

activity to its potential level over the medium term and of inflation within the target range in the

near term (¶11). At the same time, it was noted that, if signs emerge whereby price pressures

threaten to drive inflation above the mid-point of the new target range and jeopardize the still-very-

recent anchoring of inflation expectations, taking into account the lags in monetary policy

transmission, the central bank ought to start reversing the easing cycle. This consideration is

reinforced by the prospective upward normalization of global interest rates, which could induce

depreciation pressures.

Neutral Interest Rate for Costa Rica. Latest Estimates

INTERNATIONAL MONETARY FUND

3.001.752006-20152006-20151994-2015QPM Model1996-2015AverageSources: National authorities and Fund staff estimates.Notes: 1/ All units expressed as percent points unless otherwise stated. 2/ (bps): Basis pointsExpected Inflation Dic-2016Actual Monetary Policy RateMethod 1/Neutral Real Interest Rate (NRIR)Neutral Nominal Interest Rate (NNIR)Nominal Monetary Policy GAP (bps) 2/2.45.4368Uncovered Interest Parity1.64.6283Expected-Inflation Augmented Taylor RuleForward Looking Monetary Model1.84.8301General Equilibrium Model2.65.63811.44.42651.94.9320

051015202530Oct-06Jun-07Feb-08Oct-08Jun-09Feb-10Oct-10Jun-11Feb-12Oct-12Jun-13Feb-14Oct-14Jun-15Feb-16 Policy rate Nominal lending rate Real lending ratePolicy Rate and Bank LendingRates(In percent)Sources: Nationalauthorities, and IMF Staff estimates

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COSTA RICA

B. Safeguarding Fiscal Sustainability

18.

The authorities viewed current fiscal trends as unsustainable in the long term. Staff

stressed that, without any policy action, the CG deficit would be above 9 percent of GDP and debt

rise to almost 70 percent by 2021. Even in the baseline scenario, which incorporates a fiscal

adjustment of 2¼ percent of GDP, the CG deficit would persist at about 5½ percent of GDP by 2021,

owing to a mounting interest bill and constitutionally-mandated education spending.

Correspondingly, CG debt would grow to 55 percent of GDP by 2021 (from 42½ percent of GDP at

end-2015), further raising vulnerabilities and potentially eroding the underpinnings of

macroeconomic stability.

19.

The government confirmed that a fiscal adjustment of almost 4 percent of GDP is

needed to stabilize the public debt ratio. In staff’s estimates, budget retrenchment measures

amounting to 3¾ percent of GDP over the medium-term would suffice to steady the share of public

debt to GDP below levels which tend to weaken macro stability in emerging markets, while allowing

for some desirable increases in growth-friendly capital spending (Annex III). The authorities agreed

and are prepared to implement a fiscal consolidation package expected to gradually close this fiscal

sustainability gap (¶21).

20.

To pace consolidation, the authorities aptly intend to maintain a balance between

lowering the sustainability gap and limiting any adverse impact on growth. The front-loaded

fiscal consolidation appropriately planned by the government, with somewhat less than two-thirds

of the total adjustment in 2016–17 and smaller corrections in subsequent years, would have only

moderate output cost over the forecast period (¶12 and AN VI). Staff underscored that further

postponing fiscal retrenchment would be costly, since, the longer the delay, the larger will be the

improvement in the primary balance required to stabilize the public debt ratio. The authorities had

the same concern. They asked staff to explain publicly that failing to deliver on the fiscal

consolidation plan would increase the risk of an abrupt shift in investor sentiment and of acute

financial market tensions, thus forcing a disorderly adjustment.

Costa Rica. Fiscal Consolidation Path

INTERNATIONAL MONETARY FUND

(Percent of GDP)201620172018201920202021TotalTotal Adjustment0.81.61.00.10.10.13.8Baseline0.81.10.4---2.3Revenue0.41.00.3---1.7Expenditure0.40.10.0---0.6Additional Adjustment-0.60.70.10.10.11.5Revenue-0.30.5--0.8Expenditure-0.20.20.10.10.10.7Source: Fund staff estimates.

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COSTA RICA

21.

The authorities’ fiscal adjustment plans adequately focus on raising revenues, with a

sizable contribution from expenditures, but full implementation is critical. The measures in the

authorities’ plans broadly follow staff advice, including recommendations provided in past technical

assistance by the Fund and other multilaterals.

 The government’s strategy envisions about

2½ percent of GDP in higher taxes, consistent

with staff’s advice that about two-thirds of the

adjustment should consist of increases in

receipts, given Costa Rica’s low revenue effort

compared to other upper-middle-income

countries. VAT and income tax reforms would

boost collections by slightly more than 2

percent of GDP over the medium-term, and

other provisions—reduced exemptions,

further amendments to the corporate income tax and anti-tax evasion measures—would

generate almost ½ percent of GDP. The VAT reform envisages broadening the base to include

services and a gradual increase in the rate from 13 to 15 percent, starting in 2017, as well as

separate increases of taxes on sales of vehicles and real estate. The bill also foresees a radical

narrowing of the basic goods basket, conditional on the establishment of a transfers system that

would make the VAT reform broadly revenue-neutral for lower-income households. The income

tax reform introduces additional marginal rates of 20 and 25 percent on higher-income brackets,

unifies the rate on capital income at 15 percent, and subjects capital gains to tax.



Furthermore, the authorities have already identified legislative changes—including to curtail

growth of pensions paid out of the budget and transfers to decentralized entities—and

administrative measures that would yield the 1¼ percent of GDP of cuts in current

expenditures also required to fully close the sustainability gap.



The authorities share staff’s view that only the full adjustment of 3¾ percent of GDP needed

to stabilize the public-debt-to-GDP ratio would be adequate from a macro-economic

perspective. Indeed, a partial fiscal adjustment as assumed in the baseline scenario—with tax

reform proposals currently in Congress watered down and insufficient efforts to contain

spending—would result in continued large fiscal deficits driven mainly by a mounting

interest bill, and significant additional debt accumulation subject to important downside

risks under less favorable macroeconomic conditions (¶11 and Annex III). This would further

raise vulnerabilities and potentially erode the underpinnings of macroeconomic stability.



The alternative full adjustment scenario assumes Congressional approval of all submitted

measures, yielding 2¾ percent of GDP. Moreover, it includes administratively-determined

INTERNATIONAL MONETARY FUND

0510152025HNDNICSLVDOMCRIGTMPANLower-middle income countriesUpper-middle income countriesTax Revenue, 2014(Percent of GDP)Source: WEOand Fund staff calculations.

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COSTA RICA

spending cuts that would contain the growth of current spending—mostly transfers and

public sector wages—to keep it throughout the medium term below the expansion of

nominal GDP.

Costa Rica. Central Government. Fiscal Consolidation Measures

(in percent of GDP)

22.

The government is considering steps to ensure durable commitment to contain

expenditures, thus shoring up parliamentary support for fiscal consolidation. The executive

power has a minority representation in Congress; hence approval of most budget consolidation

measures requires the cooperation of opposition parties. Notwithstanding the broad consensus

across the political and societal spectrum that fiscal retrenchment is needed, some opposition

parties and influential lobbies have called for greater emphasis on lowering outlays. In this regard,

bills currently under discussion to reform public employment conditions—thus preventing excessive

automatic increases in current outlays—and a recently presented fiscal rule proposal—aimed at the

preservation of government debt sustainability, broadly in line with staff advice though still

INTERNATIONAL MONETARY FUND

TotalSubmitted to Congress, Staff Assessment 1/Additional Measures (II)Total adjustment (I + II)Total adjustment4.02.92.31.53.8Revenue2.72.51.70.82.5Anti-tax evasion0.50.20.2-0.2VAT1.31.30.50.81.3Income tax 0.60.60.6-0.6Corporate income tax 0.20.20.2-0.2Vehicles and real estate tax0.20.20.2-0.2Expenditure1.30.40.60.71.3Transfers 0.40.40.4-0.4Wages 4/0.6--0.60.6Miscellaneous cuts in 2016 budget 0.2-0.2-0.2Goods and services0.1--0.10.12/ In addition to the lower yield assumed from anti-tax evasion meaures, the difference with the authorities' plans is that it incorporates only measures that are deemed to have a higher probability of approval. The assumption in the baseline is that the proposed VAT tax rate increases will not be approved by Congress.3/ Reflects total adjustment needed to close the sustainability gap.4/ Includes measures to contain nominal growth of public wages, so that their share in GDP is gradually reduced. Also includes freeze in hiring outside education, and cuts to public compensation bonus schemes. 1/ On the revenue side, includes staff's assessment of the expected yield from revenue measures submitted to Congress. On the expenditure side, includes measures already submitted to Congress.Authorities' plans Baseline Scenario 2/ (I)Adjustment Scenario 3/

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COSTA RICA

requiring greater specification of its key elements—are welcome (AN VI). An agreement is likely to

require simultaneous advances on all aspects of the consolidation package. Despite promising

moves toward a compromise, the process could still be derailed.

23.

The authorities agree that the pension system’s financial position also has to be

strengthened in the long run. The pension plan run by the Social Security agency (CCSS) and the

special regime for the judiciary are actuarially imbalanced. They are projected to turn a cash deficit

over the long term due to system maturation and population aging. Preliminary projections suggest

that an additional adjustment equivalent to about 1½ percent of GDP would be required at the

general government level to ensure actuarial equilibrium of the CCSS for the next 50 years (AN VI). A

study commissioned by the CCSS and the Superintendence of Pensions to be released in 2016 will

determine the size the imbalance more precisely. The authorities have nevertheless already taken

some measures, including the elimination of the early retirement option, and are considering

increasing minimum contributions and gradually raising contribution rates over the medium-term

above the scheduled increases already stipulated in 2005. Several legislative proposals currently in

Congress also contemplate parametric adjustments to the special regime for the judiciary.

C. Improving the Monetary and Exchange Rate Policy Framework

24.

Staff commended the authorities for their achievements in lowering inflation and

endorsed their decision to further lower the target range. The central bank’s monetary policy

has succeeded in preventing any durable deviations from the target range since 2009 and anchoring

inflation expectations to the center of the 3-5 percent target range introduced in 2014. Based on

this, the staff supported the central bank’s decision to take advantage of the recent sharp decline in

inflation to revise the target range to 2-4 percent, in line with average inflation of trading partners.

At the same time, staff emphasized, this move should be accompanied by fiscal consolidation to

prevent the risk that an excessively tight monetary policy might be needed to contain inflation

within the target range.

25.

The authorities have made steady progress toward full-fledged inflation targeting, but

additional steps would be useful.



The mission underlined that removal in early 2015 of the legal constraint to exchange rate

flexibility posed by the XR band is a milestone toward establishing inflation as the

undisputed anchor of monetary policy and lowering XR pass-through to inflation. It also

acknowledged that the authorities’ preference for maintaining a significant role for active XR

management, with an FX intervention rule aimed both at averting excessive volatility and at

countering unwarranted deviations from medium-term fundamentals, is understandable, in

light of the large financial dollarization.



However, staff advised that a gradual, contained increase in the flexibility of the exchange

rate, in line with the stated policies of the central bank, would be important to further

strengthen the credibility of the inflation-targeting framework, as well as to enhance the role

of the exchange rate as a shock absorber and make market participants more cognizant of

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COSTA RICA

two-way risks in exchange markets, promoting the development and use of hedging

facilities and the reduction of foreign currency mismatches, while more generally

discouraging dollarization. The latter should also be pursued with the tightening of macro-

prudential norms (¶28). Moreover, the mission questioned whether the lack of transparency

of the triggers for the FX-intervention-rule aimed at curbing volatility might not, under

circumstances less favorable than those presently prevailing (¶4), undermine confidence in

the full subordination of XR management objectives to the inflation target. The central bank

agreed in principle, but emphasized that allowing more XR flexibility and more transparency

about the intervention policy should proceed in parallel with the transfer of all FX

transactions to the open market to make the XR less prone to speculative moves. Staff saw

merit in deepening the FX market, thereby facilitating higher XR flexibility.



Fostering growth of the underdeveloped secondary market for government securities,

including through use of standardized simple instruments with conventional maturities, was

also considered desirable to reinforce the effectiveness of monetary policy and enhance

resilience to external financial shocks.

D. Financial Stability

26.

The authorities acknowledge that currency mismatches in the private sector pose the

key risk to financial stability. Staff noted that Costa Rica’s current level of credit and broader

financial development is well below the threshold beyond which risks to stability outweigh the

benefits from the positive impact on growth (AN IV). In particular, the current pace of overall credit

expansion, not high by historical standards, seems consistent with continued healthy financial

deepening. Moreover, a top-down stress test

conducted by staff depicts a sound banking

sector that could absorb a range of sizable

shocks (AN II). However, large dollarization of

bank loans was jointly identified as a serious

and intensifying concern. Indeed,

notwithstanding the overall long FX position of

the banking system, a large depreciation of the

colón may impact asset quality, given

unhedged FX liabilities in large segments of the

household and corporate sectors. In particular,

staff pointed out that, according to the stress

tests, the deterioration of bank capitalization,

and related contingent liabilities for the

sovereign, could be substantial (AN II). As for the macro impact, general equilibrium model

simulations suggest that loan impairment and implied lower credit growth from, say, a twenty

percent depreciation could reduce GDP growth by about 1½ percent over the medium-term (AN I).

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-1.6-1.4-1.2-1-0.8-0.6-0.4-0.200.22015201620172018201920202021 5% depreciation and 25bp increase in MRP 20% depreciation and 300bp increase in MRPEffect on Real GDP of Adverse Shocks on FX and NPL(Percent difference from baseline)Sources: IMF staff calculation based on RES FSGMNote: NPL= Non Performing Loans; MRP= Market Risk Premium

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27.

High net foreign liabilities of banks, growing household leverage, and sovereign

exposures represent other vulnerabilities of the financial sector. After a period of large bank

borrowing abroad incurred to fund the rapid growth of FX credit to residents, Costa Rica is among

the countries in the region with highest reliance on foreign bank funding, raising concerns about

rollover risks. Indeed, staff analysis, based

on network model simulations of

spillovers from asset quality and capital

shocks in international banks, suggests

that reduced foreign bank funding could

lead to a significant reduction in credit in

Costa Rica (Panel 5 and AN II). While the

increase in private sector debt has been

limited compared to other emerging
markets,7 in Costa Rica it has been mainly
concentrated in the household sector,

and officials are aware that rising household leverage, not least via credit by non-bank commercial

entities, could also endanger asset quality. Finally, it was observed that, though starting from the low

levels prevailing before the global crisis, continuing brisk accumulation of holdings of government

debt by banks, boosted by the large fiscal deficits, is an additional hazard, particularly in an

environment where, over the medium term, interest rates are likely to increase. Although staff

recognized that, based on its analysis, banks could currently sustain losses from a significant spike in

interest rates on domestic government bonds without capital falling below regulatory requirements

(AN II), it also expressed concern that risks from mark-to-market losses on bank exposures to the

sovereign will mount without adequate fiscal consolidation.

28.

Supervisors recognized these risks and are taking positive steps to gradually reduce

them. Staff welcomed the recent increase in capital risk-weightings on FX loans to unhedged

borrowers and the extension of reserve requirements to medium- and long-term foreign bank

borrowing (in addition to the existing requirement on short-term foreign borrowing). Officials

explained that additional measures to further reduce vulnerabilities are currently under

consideration. These include: (i) stricter provisioning on FX loans to unhedged borrowers and

household debt with income-to-debt service ratios above 30 percent; (ii) counter-cyclical

provisioning; and (iii) higher risk-weightings for household mortgages with high loan-to-value and

income-to-debt service ratios. The mission deemed that these steps were appropriate, but it was not

possible yet to determine whether they would be sufficient to achieve substantial reductions in

credit dollarization and rollover risks. Staff recommended that further tightening of provisioning on

FX bank lending and of reserve requirements on FX bank borrowing (the latter requiring

Congressional action) should be contemplated, if there is no evidence of a reduction in banks’ FX

exposures within a reasonable time frame. Additionally, the coverage of the credit bureau should be

7 According to the October 2015 Global Financial Stability Report, private sector debt of emerging markets increased
from just over 60 percent of GDP in 2005 to almost 125 percent of GDP in 2014.

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-10 20 30 40 50 60 20042015 HHs, DC HHs, FX NFCs, FX NFCs, DC Bank Credit to the Private Sector(in percent of GDP) Source:National authorities and IMF staff estimates.

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COSTA RICA

extended to loans to households granted by non-bank entities to better assess household leverage

and preserve asset quality.

29.

Staff urged speedier implementation of the pending 2008 FSAP recommendations. Key

points (Annex I) include empowering the Superintendence of Financial Institutions to conduct

consolidated supervision, providing legal protection to bank supervisors in line with international

best practice, strengthening bank resolution procedures, and broadening the supervisory perimeter

to non-bank financial institutions, all of which require new legislation. The authorities remarked that

advances remain slow due to the crowded legislative agenda, but also stressed that introduction of

further legal protection for bank supervisors faces strong opposition and is constitutionally

controversial. Staff commended the progress made towards full implementation of risk-based

supervision, although efforts to bring it up to best standard should be stepped up. The FSAP update

tentatively planned for 2017 will allow for a more thorough assessment of the financial system and

determine the need for additional measures.

30.

Officials reiterated their support for gradual adoption of Basel III standards. Staff

concurred that it would further improve resilience of the financial system and thus welcomed the

recent enactment of the Basel III Liquidity Coverage Ratio. The regulatory and risk management

frameworks would also greatly benefit from introducing Basel III definitions of capital, a capital

conservation buffer, and a leverage ratio. Staff analysis shows that this could be accomplished

without significant detrimental effects on growth.

31.

It was agreed that further improvements in the effective supervision of cross-border

financial operations are critical for stability. Such a requirement has become more urgent

because financial linkages within the region have been growing, though they are not yet fully

understood, owing in part to data limitations but also to legal restrictions on information sharing.

Enhancing transnational monitoring is especially important for Costa Rica, since conglomerate BCT

operates in Panama and regional integration plays an important role in the transmission of financial

shocks (AN I). In this respect, staff welcomed Costa Rica’s participation in the system of multilateral

MoUs and in the Central American Council of Banking Supervisors. In addition, strengthening the

AML/CFT supervision of cross-border financial operations and implementing the recommendations

of the GAFILAT mutual evaluation report would assist in safeguarding the financial sector against
illicit financial flows, notably to and from higher-risk jurisdictions.8 Swift adoption at the national
level of the relevant recommendations in the WHD Cluster Surveillance Report on Financial

Integration in CAPDR (Annex II) and strengthening of the national institutional framework in support

of the medium-term Regional Macroprudential Policies Project for CAPDR would also help identify

likely spillovers and assess joint risks.

8 GAFILAT is the FATF-style regional body of which Costa Rica is a member.

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COSTA RICA

Note: See Annex I for details on the status of implementation.

Costa Rica. Summary of Stress Test Results

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Costa Rica. Financial System Assessment Program (FSAP) Main Pending Recommendations (2008) Prudential Supervision and Regulation(cid:160)(cid:160) Amend the legal framework in order to provide protection for supervisors while performing their responsibilities in good faith.(cid:160)(cid:160) Introduce pertinent laws for the Superintendency of Banks (SUGEF) to be able to supervise banking groups (including offshore structures) on a consolidated basis. Upon the approval of such laws the SUGEF should issue without delay operational regulations to ensure its rapid implementation by the banking system. (cid:160)(cid:160) Apply higher risk weight ratios to unhedged borrowers for capital adequacy purposes.(cid:160)(cid:160) Modify the funding arrangements for supervision, in line with international best practices. Crisis Management and Bank Crisis Resolution Framework(cid:160)(cid:160) Amend article 155 of the Central Bank law in order to grant the SUGEF an appropriate range of supervisory tools to require a bank to take prompt remedial action and to impose penalties in accordance with the gravity of a situation.(cid:160)(cid:160) Amend the rating system for prompt corrective actions, to include new directives that allow the SUGEF to take an appropriate range of remedial actions and supervisory decisions.(cid:160)(cid:160) Improve the early warning system, to allow the adoption of remedial actions in a timely manner.(cid:160)(cid:160) Eliminate the emergency loan window and improve the design and operational arrangements of the ordinary rediscount window, including by establishing prudential limits in terms of regulatory capital.(cid:160)(cid:160) Establish a deposit insurance scheme, in line with international best practices.(cid:160)(cid:160) Amend the bank resolution legal framework to include purchase and assumption type techniques.(cid:160)(cid:160) Enable voluntary, extra-judicial corporate restructuring agreements.

All BanksState OwnedDomestic PrivateForeignSummary of Results SolvencyPre-shock CAR17.018.012.215.9Impact of (percentage points of the original RWA)Increase in NPLs 1/-1.7-1.7-1.6-1.8Increase in interest rates 2/-0.1-0.3-0.50.3Exchange rate depreciation 3/-2.2-2.2-2.4-2.2Post-shock CAR (percent of post-shock RWA)13.113.97.812.2Change in CAR (all fundamental shocks)-4.0-4.1-4.4-3.7Impact of interbank contagionPost-contagion CAR13.113.97.812.2Post-contagion CAR if profits used for defense13.514.58.112.6Liquidity 4/Liquid assets/total assetsPre-shock22.622.319.923.4Post-shock (after 5 days)4.02.44.87.1Liquid assets/short-term liabilities0.00.00.00.0Pre-shock69.963.580.784.2Post-shock (after 5 days)36.316.7106.9117.1Source: SUGEF; and IMF staff estimates.1/ Assumes an increase in NPLs of 8 percent of performing loans; and a 25 percent provisioning rate. The sectoral shock to NLP assumes that 6 and 10 percent of the loan portfolio to the construction and trade sectors respectively become non-performing. 2/ Assumes a 3.5 percentage points nominal interest rate increase.3/ Assumes a 14 percent depreciation of the FX rate, leading to 6 percent of FX loans becoming non-performing, and a 50 percent provisioning rate. 4/ Assumes a 10 and 8 percent per day withdrawal of demand deposits in domestic and foreign currency respectively; and a 5 and 3 percent per day withdrawal of time deposits in domestic and foreign currency respectively.

Page 30

Figure 1. Costa Rica: Stress Test Results

COSTA RICA

INTERNATIONAL MONETARY FUND

CostaRica: Stress Test ResultsSource: SUGEF, and IMF staff estimates. Note:The Credit Risk Shock assumes an increase in NPLs of 8 percent of performing loans; and a 25 percent provisioningrate. TheInterest Rate Shock assumes a 3.5 percentage points nominal interest rate increase. The FX Shock assumes a 14percent depreciation of the FX rate, leading to 6 percent of FX loans becoming NPL, and a 50 percent provisioning rate. The Liquidity Shock assumes a 10and 8percent per day withdrawal ofdemand depositsin domestic and foreign currencyrespectively; and a 5 and 3 percent per day withdrawal of time deposits indomestic and foreign currency respectively. 0510152005101520All BanksState OwnedDomesticPrivateForeign Pre-Shock System-wide shock Sectoral shockCREDITRISK: Capital Adequacy Ratio(Percent of Risk-Weighted-Assets) 00.20.40.60.8100.20.40.60.81All BanksState OwnedDomesticPrivateForeign Pre-Shock 10 years averageROA(Percent of Pre-Shock Assets) 0246802468All BanksState OwnedDomesticPrivateForeign Pre-Shock 10 years averageROE(Percent of Pre-Shock Equity) 05101520253035SimulatedSystem-wideCAR<108 banksCAR<1050% marketshare<10REVERSESTRESSTEST: NPL Increase for Simulated Scenarios(Percent of Performing Loans) 051015202530051015202530All BanksState OwnedDomesticPrivateForeign Pre-Shock Post-Shock N. of liquid banksLIQUIDITYRISK: Liquid Assets/Total Assets(Percent, after 5 days)15834 0510152005101520All BanksState OwnedDomesticPrivateForeign Pre-Shock Post-Shocks Post-ContagionCOMBINEDSHOCK: Capital Adequacy Ratio(Percent of Risk-Weighted-Assets) 0510152005101520All BanksState OwnedDomesticPrivateForeign NII Repricing NII + RepricingINTERESTRISK: Capital Adequacy Ratio(Percent of Risk-Weighted-Assets) 0510152005101520All BanksState OwnedDomesticPrivateForeign Direct Indirect Direct + IndirectFX RISK: Capital Adequacy Ratio(Percent of Risk-Weighted-Assets)

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COSTA RICA

E. Structural Reforms

32.

Further structural reforms are needed to buttress Costa Rica’s competitiveness and

promote inclusive growth. While Costa Rica ranks favorably in many business indicators and has

been a regional leader in attracting foreign direct investment, further steps are needed to maintain

the country’s competitive edge (Box 1). Staff argued that a better separation of electricity generation

from the natural monopoly element associated with electricity transmission and distribution would

allow private generators to compete more effectively with the state-owned enterprise ICE, thereby

increasing efficiency. Besides, revised price-setting procedures to enhance cost discipline could help

bring down electricity tariffs, especially for the industrial sector. The authorities observed that the

private sector already participates in electricity generation and that overall electricity provision

coverage and reliability in Costa Rica are high in the region. With regards to human capital, officials

deemed that there were significant margins to improve the efficiency of public social and education

spending, which would help protect vulnerable groups and lift outcomes without jeopardizing the

budget. Expanded child-care provision and early childhood education as well as ameliorating

infrastructure, including for IT, would facilitate increased female labor force participation (AN IX).

Contribution to Female Labor Force Participation

in CRI and LA5 (Difference)

4
2
0
-2
-4
-6
-8

y
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Sources: ENAHO, 2012.

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e

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00.20.40.60.811.21.41.61.82015201620172018201920202021 Output gap Real GDP CPI inflationReal Effect of Halving Collateral Requirements(Percent difference from baseline)Sources: IMF staff calculation based on RES FSGM

-1-0.500.511.522.52015201620172018201920202021 Real corporate interest rate Real GDP CPI inflationReal Effect of Reducing Interest Rate Spreads(Percent difference from baseline)Sources: IMF staff calculation based on RES FSGMNote: The reduction in interest rate spreads is modeled as a 100bp decrese in market risk premiums

050100150200250300Value of Collateral Neededfor a Loan (% of the LoanAmount) % of Firms With an Account% of Firms With BankLoans/line of Credit% of Firms not needing aloan% of Firms Using Banks toFinance Investments% of Firms IdentifyingAccess/cost of Finance as aMajor Constraint Working Capital BankFinancing (%)LAC and EMs: Enterprise Use of Financial Services(Percent) EM Asia LAC Non-Asia/LAC EM CRI

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COSTA RICA

More generally, discussions underscored that addressing infrastructure bottlenecks, especially in the

transportation sector—as the fiscal adjustment creates space for higher public investment (¶19)—

and streamlining business regulations, not least to facilitate entry of new firms, would also stimulate

competiveness and help accelerate potential growth.

33.

Staff analysis indicates that the financial sector remains underdeveloped, especially

outside the banking area, relative to the country’s level of income and other determinants

(¶26 and AN IV). Also, while Costa Rica ranks high for inclusion of households, that of enterprises is

low relative to the country’s fundamentals (AN V). It would be important to take measures to foster

capital market development including through more market-friendly debt management and

issuance strategies that promote larger secondary markets for government securities (¶25), as well

as through better protection of investor rights and development of a larger institutional investor

base. Stepping up competition among banks, refining loan-provisioning rules to avoid high

collateral requirements being used as a substitute for proper credit-risk analysis, and further

ameliorating the judicial enforcement of secured and unsecured claims would also help reduce

financial constraints and support financial deepening. The authorities agreed that these actions

should permanently lower interest rate spreads and borrowing costs, with positive effects on credit,

investment and growth.

STAFF APPRAISAL

34. Macro prospects are generally benign, though downside risks, mainly from the weak

fiscal position, prevail. Costa Rica’s economy has been expanding below trend for the past three

years. Despite a growth uptick in 2015, unemployment remained high and inflation sharply declined,

under the combined effect of the widening output gap and the drop in oil prices. Nonetheless, the

currency has been stable and reserve accumulation resumed strongly in 2015, as the current account

deficit narrowed and foreign direct investment inflows remained strong. Growth is expected to pick

up again in 2016, with inflation moving to the middle of the new target range by end-year. Output is

anticipated to return to potential over the medium term. However, high budget imbalances cloud

the horizon. The real effective exchange rate continues broadly in line with economic fundamentals.

35.

Persistence of large fiscal deficits and a growing public debt, as well as the high credit

dollarization, have increased vulnerability to financial shocks. In the absence of policy action,

public debt is unsustainable in the long term and could reach close to 70 percent of GDP by 2021,

with attendant funding and rollover concerns. Substantial currency depreciation would likely trigger

an increase in non-performing loans given banks’ sizable foreign currency lending to non-hedged

private borrowers. As a small open economy, which relies on agricultural products and tourism for a

third of its exports and imports all its oil, Costa Rica is also exposed to external trade shocks.

36.

Current economic conditions call for immediate fiscal tightening and the continuation

of an accommodative monetary policy. The authorities’ intention to start gradually reducing the

fiscal deficit from this year onward is timely. The ongoing accommodative monetary policy,

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COSTA RICA

warranted by the low inflation and negative output gap, would help offsetting the short-term

contractionary effects of the fiscal adjustment.

37.

A sizable fiscal correction is the key priority and there are still margins to implement it

at a measured pace. A total budgetary adjustment of 3¾ percent of GDP over the medium-term is

required to stabilize the public debt ratio at a safe level. This consolidation effort is consistent with

the plans announced by the government to increase revenues by about 2½ percent of GDP and

decrease expenditures by around 1¼ percent of GDP. To minimize the negative impact on output

and since financing is still available, the correction should be phased gradually over 2016-2020,

though with a significant front-loading to lend credibility to the fiscal adjustment package.

38.

Budget consolidation should rely mainly on tax increases, given a comparatively low

revenue effort, but expenditure containment is a necessary complement. It is advisable to

bring Costa Rica’s tax collection closer to that of other upper-middle income countries, while

increasing the progressivity of the tax system, as in the government’s plan. Indeed, the announced

tax measures aptly include a broadening of the base and a rate increase for the VAT, the

introduction of two new brackets in the personal income tax for high earners, the reduction of tax

exemptions, and a strengthening of sanctions against evasion. A refund system would compensate

lower-income households for the VAT hike. A reduction in the growth of current expenditures below

nominal GDP growth, in particular of public sector wages and transfers, is also necessary to fully

close the fiscal sustainability gap. Current legislative proposals for public employment reform to

prevent excessive automatic wage increases and for a fiscal rule to ensure public debt sustainability

are useful tools to buttress longer-term fiscal discipline.

39.

The authorities have appropriately strengthened the inflation-targeting framework,

but greater XR flexibility is desirable. The central bank has managed to lower inflation and to

anchor inflation expectations to the center of the 3-5 percent target range introduced in 2014, thus

creating the conditions for the further downward revision of the target range in early 2016. The XR

band was successfully removed in early 2015, thereby confirming inflation as the key objective of

monetary policy, while maintaining XR stability, thanks partly to recurring FX interventions and a

favorable external environment. However, a gradual increase in XR flexibility, which could be

facilitated by a concurrent deepening of the FX market, would enhance the XR’s role as a shock-

absorber and encourage awareness by private agents of two-way risks in exchange markets. An

improvement in the central bank’s communication about FX interventions is also warranted.

40.

Regulatory upgrades should primarily aim at reducing financial dollarization, but it is

important also to strengthen cross-border supervision and creditworthiness scrutiny. FX

lending, funded by foreign borrowing, is growing faster than lending in colones, despite the recent

tightening of reserve requirements on bank foreign borrowing and increase in capital risk weights

for foreign currency loans to un-hedged borrowers. Although staff analysis suggests that associated

risks are currently manageable even under extreme stress scenarios, further strengthening of

prudential measures may be necessary should this trend continue. The implementation of pending

2008 FSAP recommendations and the gradual adoption of Basel III standards, as well as

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COSTA RICA

improvements in cross-country supervision, should reinforce the existing regulatory and supervisory

framework. The extension of the credit bureau’s coverage would facilitate credit risk monitoring and

thus also support financial deepening. In addition, removing competition distortions between public

and private banks would help lower interest rate spreads and improve credit supply.

41.

Boosting Costa Rica’s growth potential and competitiveness requires energy sector

reform, infrastructure upgrades, and education reform. Greater private sector participation in

the energy sector along with a review of tariffs would allow for a reduction in the cost of electricity

for firms. An additional investment effort is needed to address infrastructure bottlenecks, in

particular in the transportation sector. Sizable government education expenditures, already close to

the constitutional mandate of 8 percent of GDP, should put more emphasis on early childhood and

the secondary level with the goal of reducing drop-outs in secondary grades. More generally, gains

in efficiency of education and social spending would especially benefit the most vulnerable

segments of the population and foster more inclusive growth.

42.

It is recommended that Costa Rica remain on the standard 12-month consultation

cycle.

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Box 1. Costa Rica: External Stability Assessment

The real effective exchange rate (REER) continues to be broadly in line with fundamentals. Staff has used

various approaches to assess the appropriateness of the external balance and real exchange rate. These include

descriptive quantitative indicators, regression-based methods to estimate the distance of the current account (CA)

balance and the REER from the values determined by their fundamentals and desirable policy settings, as well as

stability conditions for net foreign assets.

The REER has been stable in 2015 and early 2016, at a level about 6 percent higher than at the beginning of

2014. In the first half of 2014, nominal depreciation outpaced a growing inflation differential with the main trading

partner (USA), resulting in substantial REER depreciation that eliminated a third of the accumulated 30 percent

REER appreciation since 2003. In the second half of 2014, however, the REER appreciated by 14 percent, reversing

the depreciation occurred during the first half of the year. The REER adjusted for the Balassa-Samuelson effect

shows that total REER appreciation since 2003 was driven by the labor productivity differential between Costa Rica

and the U.S., and therefore reflects changes in fundamentals, rather than unsustainable developments.

At the same time, the CA deficit has declined and the non-Intel export market share has increased (see chart

below). The CA deficit has improved reaching around 4 percent of GDP in 2015 on the back of low fuel prices and

continued strong positive services balance. While the Intel exit in 2014 had a significant impact on Costa Rican

exports (16 percent less cumulatively in 2014-15), it had a muted impact on the overall trade balance due to the

small domestic value added of the company. At the same time, non-Intel exports have gained export market share

in the world markets increasing by 3 percent relative to 2014.

The financing structure of the CA and somewhat low external liabilities mitigate risks. The CA is largely

financed by FDI inflows. While the IIP is negative at almost 45 percent of GDP, FDI comprises almost 65 percent of

total liabilities. The external debt profile presents no sustainability concerns, with the external debt-to-GDP ratio

set to decline into the medium term and a low share of short-term debt. Net international reserves stood at

5.8 months of non-maquila imports of goods and services at end-2014 and are above the Fund’s composite

reserve adequacy metric.

Sources: INS; St. Louis Fed; national authorities; and Fund staff calculations.

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90100110120130140200020012002200320042005200620072008200920102011201220132014Real Exchange Rate Measures REER REER adjusted for productivity differential

4050607080901001101202000200120022003200420052006200720082009201020112012201320142015Costa Rica's Export Share in World Exports Adjusted for Intel Index (2000=100)

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COSTA RICA

Box 1. Costa Rica: External Stability Assessment (concluded)

IMF’s multilaterally consistent estimates suggest that Costa Rica’s REER is broadly in line with
fundamentals and desirable policy settings both in the short term and relative to medium-term
benchmarks.



The macro-balance approach in the External Balance Assessment (EBA) estimates the sustainable CA implied

by existing fundamentals and desirable policies. It points to a current account norm deficit of 4.7 percent of

GDP in 2015, which is about 0.8 percent of GDP larger than the actual cyclically-adjusted deficit of 3.9

percent of GDP in 2015, implying a REER undervaluation of 3.5 percent. Identified policy gaps in Costa Rica

are negative and significant at -1.7 percent of GDP, suggesting further undervaluation if corrected. Health

expenditures, which are significantly higher than the world average, as well as recommended fiscal

adjustment, explain 70 and 30 percent of the policy gap respectively.



The macro-balance approach based on the CA panel regression (which relies on medium term fundamentals

and assesses the medium-term current account) estimates REER overvaluation of 3.1 percent.



The external sustainability (ES) approach, on the other hand, finds a moderate overvaluation of 6.8

percent. However, taking into account the favorable financial structure of external liabilities of Costa Rica,

by excluding FDI from the stock of total liabilities, would imply an undervaluation of a similar size.

Staff views the results based on the macro-balance approaches, which both assess the external sector to be

neither over- or undervalued, as the most reliable. The simple average across the different methodologies

supports this assessment as well. Staff concludes that Costa Rica’s REER is in line with fundamentals.

The recent withdrawal of Intel operations does not reflect deterioration in external competitiveness. First,

the shut down operations had a very small value added. Competitiveness of Costa Rica, as a well-educated upper

middle-income country, should be assessed against other middle-income countries that operate in a different

market segment with a higher value added. Second, while the withdrawal had a sizable effect on total exports,

non-Intel exports gained market share in 2014 and are expected to improve further in 2015. Third, Intel research

operations remained in Costa Rica indicating stable demand for highly qualified labor in the country.

While regulatory quality and efficiency has improved, some sectors continue to weigh on overall

competitiveness. Costa Rica gained 21 positions in the 2016 Doing Business Survey by the World Bank driven by

improved access to credit, introduction of an electronic tax payment system, and easier access to electricity.

According to the Global Competitiveness Index by the World Economic Forum, however, Costa Rica’s

competitiveness has remained at the same level as last year. Unsatisfactory infrastructure, concerns over inefficient

government spending, and insufficient investor protection continue to weigh on competitiveness.

INTERNATIONAL MONETARY FUND

Page 37

COSTA RICA

Figure 2. Costa Rica: Recent Developments and Prospects, Real Sector

Real GDP growth has picked up over the last few years,
catching up with trends in other CAPDR countries…

… as a result of stronger domestic demand growth, which

in 2015 benefitted from…

Real GDP Growth
(Percent)

-2

Simple average of selected
Central American countries 1/
Costa Rica

2008 2009 2010 2011 2012 2013 2014 2015

.… improved terms of trade that helped offset...

As a result, a moderate negative output gap has opened
up that is expected to persist, while gradually shrinking,
for several years.

… the impact of Intel’s closure and adverse weather
conditions for agriculture exports.

Meanwhile, inflation has turned negative, driven by lower
oil prices, and inflation expectations have converged to the
target.

Sources: National authorities; Haver Analytics; and Fund staff calculations.

INTERNATIONAL MONETARY FUND

-20-15-10-50510152020052006200720082009201020112012201320142015F Contribution from import prices Contribution from export prices Terms of TradeTerms of Trade Changes and Contributions From Import and Export Prices(Y/Y changes in percent)

-8-40481216Jan-10Jul-10Jan-11Jul-11Jan-12Jul-12Jan-13Jul-13Jan-14Jul-14Jan-15Jul-15Jan-16 IMAE IMAE, excluding FTZ IMAE, agriculture IMAE, manufacturing Monthly Index of Economic Activity (IMAE)(Y/Y changes in percent)

-202468 Output gap Potential GDP growth Actual GDP growthReal GDP Growth and the Output Gap(Percent)

-404812162024Feb-08May-08Aug-08Nov-08Feb-09May-09Aug-09Nov-09Feb-10May-10Aug-10Nov-10Feb-11May-11Aug-11Nov-11Feb-12May-12Aug-12Nov-12Feb-13May-13Aug-13Nov-13Feb-14May-14Aug-14Nov-14Feb-15May-15Aug-15Nov-15Feb-16 Target band Headline inflation Inflation expectations (12-months) Core inflationHeadline Inflation(Percent, y-o-y)

-10-505101520200720082009201020112012201320142015 Imports Exports Domestic demandRealGDP Growth: Contribution of Demand Components 2/ (Percent)

Page 38

Figure 3. Costa Rica: Recent Developments, External Sector

COSTA RICA

In 2015, a lower current account deficit driven mainly by
lower oil prices…

.… have resulted in strong international reserve
accumulation to levels above adequacy metrics.

While the real exchange rate is assessed to be in line with
fundamentals, a ULC-based REER including public wages
in Costa Rica highlights risks to competitiveness…

.… together with resilient FDI, new government external
bond issuance, and higher bank net foreign liabilities…

The real effective depreciation of early 2014 has been
reversed driven both by nominal appreciation and
inflation differentials.

…if wages in public wage inflation were to spill over into
the private sector, at a time when productivity growth
appears to be slowing.

Sources: WEO; national authorities; and Fund staff calculations.
1/ Increase implies appreciation.
2/ The REER based on ULC was calculated with data for 73 percent of the trading partners. Wages are for total employment in
Costa Rica and manufacturing sector in trading partners

INTERNATIONAL MONETARY FUND

-30-26-22-18-14-10-6-2261014200720082009201020112012201320142015F Income & transfers Service balance Oil imports Non-oil trade balance Current account balanceCurrent Account Balance and Its Components(Percent of GDP)

-1.0-0.50.00.51.01.52.02.53.02010Q12010Q32011Q12011Q32012Q12012Q32013Q12013Q32014Q12014Q32015Q12015Q3 FDI Portfolio Other investmentCosta Rica: Composition of the Financial Account in the BOP (Billions USD)

051015202530354045CRIDOMSLVGTMHNDNICPAN Gross international reserves 3 months of imports 100 percent of short-term external debt ARA EM metricReserve Coverage,2015(Percent of GDP)

-15-551525354555657585Jan-05Jan-06Jan-07Jan-08Jan-09Jan-10Jan-11Jan-12Jan-13Jan-14Jan-15Jan-16 REER REER ULCReal Effective Exchange Rate1/ 2/ (Changes in percent since January 2005)

-1.5-1.0-0.50.00.51.01.52.02.53.03.52000200120022003200420052006200720082009201020112012201320142015Total Factor Productivity Growth Estimates(In percent)

-100-75-50-250255075100Jan-05Jan-06Jan-07Jan-08Jan-09Jan-10Jan-11Jan-12Jan-13Jan-14Jan-15Jan-16 NEER Relative Prices REERReal Effective Exchange Rate1/ (Changes in percent since January 2005)

Page 39

COSTA RICA

Figure 4. Costa Rica: Recent Developments and Prospects, Fiscal Sector

… was matched by similar growth in primary expenditure…

Public debt is expected to continue to rise sharply under
the baseline scenario driven mainly by the interest bill…

… plus an increasing likelihood of a debt spiral with
potentially non-linear increase in financing costs as debt
continues rising.

In 2015, strong revenue growth from efforts to reduce tax
evasion…

… leaving the primary and overall fiscal deficits close to
the post-global credit crisis highs.

… and risks tilted to the upside…

1/ Gross financing needs for LA-5 are based on data from latest Article IV reports, published in 2015.

Sources: National authorities; and Fund staff estimates.

INTERNATIONAL MONETARY FUND

051015202530352006-072008-1020112012201320142015E Total revenues central govt. Total revenues NFPS Nominal GDPRevenues and Nominal GDP(Annual growth in percent)

051015202530352006-072008-1020112012201320142015E Central govt. NFPS Nominal potentialGDPNon-interest Expenses and Nominal Potential GDP(Annual growth in percent)

-10-8-6-4-202468200720082009201020112012201320142015E Fiscal impulse (structural primary balance, change) Overall balance Primary balanceFiscal Balances of the Central Government (Percent of GDP)

020406080100GTMNICDOMCRISLVPANHND 2014 Pension Debt 2008 2020 EMs (2020)Debt of the Central Government(Percent of GDP)

35404550556065707520142015201620172018201920202021Fan ChartEvolution of Debt-to-GDP ratio 75th-90th 50th-75th 25th-50th 10th-25th Baseline

DOMPANCRIGTMSLVHNDCHIBRCOLMEXPER 01002003004005006007008002712EMBI spreads, in basis pointsGross financing needs, 2015-16 average, in percent of GDPGross Financing Needs and EMBISpreads 1/

Page 40

Figure 5. Costa Rica: Recent Developments, Financial Sector

COSTA RICA

Financial conditions remain relatively tight…

… reflecting both limited pass-through to nominal rates in
the banking system and a significant decline in inflation
expectations.

.… with real lending rates rising despite the aggressive
monetary easing…

Credit growth has moderated in line with sluggish
economic activity.

Sources: National authorities; and Fund staff estimates.

INTERNATIONAL MONETARY FUND

-12-8-40481216-3-2-101234Dec-07Jun-09Dec-10Jun-12Dec-13Jun-15 Overall FCI Real GDP growth (rhs)Monetary and Financial Conditions Index(Percentage points of y-o-y real GDP growth)

0510152025303540Oct-06Jun-07Feb-08Oct-08Jun-09Feb-10Oct-10Jun-11Feb-12Oct-12Jun-13Feb-14Oct-14Jun-15Feb-16 Policy rate Nominal lending rate Real lending ratePolicy Rate and Bank LendingRates(In percent)

05101520253035Feb-06Feb-07Feb-08Feb-09Feb-10Feb-11Feb-12Feb-13Feb-14Feb-15Feb-16 Lending rate Deposit rate (basic borrowing rate)Lending and DepositRates (In percent)

Page 41

COSTA RICA

Figure 6. Costa Rica: Financial Sector Vulnerabilities

Banks are adequately capitalized and NPLs remain low,
although profitability has been declining.

Despite the moderation in overall credit growth, credit in

FX is accelerating again spurred by renewed exchange rate
stability.

As a result, Costa Rica is one of the countries with highest
credit dollarization in the region…

… although associated rollover risks still appear
manageable.

Sources: BIS; IFS; and Fund staff estimates.

INTERNATIONAL MONETARY FUND

… and one of the most reliant on foreign financing…

Exposure to a sovereign with high and rising public debt is
another area of concern, although these are still limited by
regional standards.

0.00.30.60.91.21.51.82.1-10-50510152025201020112012201320142015 Regulatory capital to RWA NPLs to total loans Minimum regulatory capital to RWA Return on asseets (rhs)Financial System Indicators(In percent)

-20-100102030405060Feb-05Feb-06Feb-07Feb-08Feb-09Feb-10Feb-11Feb-12Feb-13Feb-14Feb-15Feb-16 Total In domestic currency In foreign currencyCredit to the private Sector (Y/Y growth, in percent)

020406080100URYPRYCRIGTMHNDDOMCHLMEXCOLBRA Peak in the 2000s LatestShareof Credit in Foreign Currency(In percent)

-15-10-5051015CRISLVGTMCOLHNDCHLBRADOMMEXPANNIC Jul-10 Jul-15 Dec-07Net Bank Foreign Liabilities to Total Assets(Percent)

-30-25-20-15-10-505101520CRIDRSLVGTMHNDNICPAN UK USA and Canada Germany France Spain Japan Greece, Ireland, and PortugalSpillovers from International Banks' Exposures as of October 2015: Effect on Credit of 10% Loss in All Bank Assets of BIS-Reporting Banks, RES Bank Contagion Module (Percent of GDP)Note: In Panama, the loss of credit includes credit by banks in the off-shore center with minimal links to the domestic economy.

01020304050MEXBRAGTMCOLCRIDOMURYHNDPANSLVNICPANECUCHLBOLBankClaims on Central Government(In percent of total domestic claims)

Page 42

Figure 7. Costa Rica: Competitiveness and Structural Reforms

Costa Rica’s competitiveness indicators have improved over the last decade, and only lag the more advanced countries in
the region in a few areas, like the macroeconomic environment due to the country’s unsustainable fiscal situation.

COSTA RICA

Electricity tariffs are not very high by regional standards,
but Asian competitors with subsidy policies generally have
lower tariffs.

Measures are needed to take Costa Rica past the low point
of the typical U-shaped relationship between development
and female participation.

Efficiency of (high) expenditure on education, which is low
compared to Asia and also to Chile, needs to be improved.

Increasing competition in the banking sector would
provide a significant boost to the economy.

Source: World Bank, Doing Buisness Report; World Economic Forum, The Global Competitiveness Report 2015;
Latin American Energy Organization (OLADE); National Center for Education Statistics, PISA tests; and Fund staff
calculations based on RES FSGM.

INTERNATIONAL MONETARY FUND

Overall ScoreStart a businessDealing with Construction PermitsGetting ElectricityRegistering PropertyGetting CreditProtecting Minority InvestorsPaying TaxesTrading Across BordersEnforcing ContractsResolving Insolvency CRI, 2015 CRI, 2010 LA-5, 2015 CAPDR, 2015World Bank Doing Business Report

InstitutionsInfrastructureMacro environmnetHealth and primary educationHigher education and trainingGoods market efficiencyLabor market efficiencyFinancial market developmentTechnological readinessMarket sizeBusiness sophisticationInnovation LA-5 CAPDR CRI-2006 CRI-2015WEF CompetitivenessIndex

-100102030405060MYSKORUSACHNMEXOECDCRIDEUGTMSLVBRAJPNHNDNICDOM Residential Industrial DifferenceAverage Electricity Tariffs as 2011(Residential vs. industrial, in USD cents/KwH)

Argentina Australia Brazil Chile Colombia Costa Rica Finland France HKIndonesia Japan KoreaLatviaNetherlands New Zealand Peru Romania SerbiaSingapore Slovak Republic Spain Switzerland Thailand Tunisia Vietnam 23456789350400450500550600Expenditure on education (% of GDP, 2012)Average score of 15-year old students on mathematics, sience and literacy PISA testsEfficiency of Expenditure on Education

01020304050607080901006789101112FLFP RateLog GDP Per Capita Other Costa Rica Central America LAC5Female Labor Force Participation

0.00.51.01.52.02.53.03.54.04.52015201620172018201920202021 100bp reduction in interest rate spreads Halving collateral requirementsEffect of Higher Banking Competition on Real GDP (Percent difference from control)

Page 43

COSTA RICA

Table 1a. Costa Rica: Selected Social and Economic Indicators, Baseline Scenario

(Partial Fiscal Adjustment) 1/ 2/

INTERNATIONAL MONETARY FUND

Page 44

Table 1b. Costa Rica: Selected Social and Economic Indicators,

Full Fiscal Adjustment Scenario 1/ 2/

COSTA RICA

INTERNATIONAL MONETARY FUND

Population (2014, millions)4.8 Human Development Index Rank (2013)68 (out of 187)Per capita GDP (2014, U.S. dollars)10,425 Life expectancy (2013, years)80.0Unemployment (2014, percent of labor force)9.7 Literacy rate (2014, percent of people ages > 15)98.0Poverty (2014, percent of population)22.0 Ratio of girls to boys in primary and secondaryIncome share held by highest 10 percent of households39.4 education (2013, percent)103.0Income share held by lowest 10 percent of households1.7 Gini coefficient (2012)48.6Est.201220132014201520162017Output and PricesReal GDP growth5.21.83.03.74.24.2Output gap (percent of potential GDP)2.80.4-0.8-1.1-0.9-0.7GDP deflator3.94.24.72.23.63.1Consumer prices (end of period) 4.63.75.1-0.83.03.0Money and CreditMonetary base16.910.210.49.29.99.0Broad money10.77.715.46.68.98.2Credit to private sector 13.412.217.511.812.412.9Monetary policy rate (percent; end of period)5.03.85.32.3……Savings and InvestmentGross domestic investment 20.518.819.619.119.119.3Gross domestic savings15.313.814.915.114.815.1External SectorCurrent account balance -5.2-5.0-4.7-4.0-4.2-4.2 Of which: Trade balance-11.6-11.3-10.5-10.2-10.2-10.3Financial and capital account balance9.56.44.66.25.15.0 Of which: Foreign direct investment4.14.84.04.14.34.3Change in net international reserves (increase -) -2,110-461113-622-500-500Net international reserves (millions of U.S. dollars)6,8577,3317,2117,8348,3348,834Public FinancesCentral government primary balance-2.3-2.8-3.1-3.0-2.4-0.9Central government overall balance-4.5-5.6-6.0-5.8-5.7-4.4Central government debt34.336.039.342.444.946.2Consolidated public sector overall balance 3/-4.5-5.4-5.6-6.0-6.1-4.7Consolidated public sector debt 4/37.642.043.246.047.748.4 Of which: External public debt7.38.910.511.712.212.7Memorandum Item:GDP (US$ billions)46.549.649.652.957.060.8Sources: Central Bank of Costa Rica, Ministry of Finance, and Fund staff estimates.4/ The consolidated public debt nets out central government and central bank debt held by the Caja Costarricense del Seguro Social (social security agency) and other entities of the nonfinancial public sector.(Annual percentage change, unless otherwise indicated)(In percent of GDP, unless otherwise indicated)1/ Includes measures as in the baseline partial adjustment scenario, as well as administratively-determined measures to contain growth in the wage bill, and increases in the VAT rate from 2017.3/ The consolidated public sector balance comprises the central government, decentralized government entities, public enterprises, and the central bank, but excludes the Instituto Costarricense de Electricidad (ICE).Proj.2/ Data for 2012-15 reflect new nominal and real GDP data released by the authorities under new statistical standards and new base year 2012. The methodological changes resulted in an upward revision in nominal GDP of about (cid:160)2½ percent in the base year, as a result mainly of a higher share of the rapidly growing services sector. Pending the release of the full new historical GDP series, nominal and real GDP prior to 2012 are staff estimates using new 2012 GDP data by component, and available past growth rates of components under the old standards.

Page 45

COSTA RICA

Table 2. Costa Rica: Balance of Payments,

Baseline Scenario (Partial Fiscal Adjustment) 1/ 2/ 3/

INTERNATIONAL MONETARY FUND

Est.201020112012201320142015201620172018201920202021Current Account-1,281-2,228-2,408-2,486-2,340-2,135-2,396-2,590-2,759-3,015-3,217-3,463Trade balance-3,440-5,144-5,375-5,623-5,212-5,370-5,807-6,312-6,952-7,702-8,394-9,180Export of goods (f.o.b.)9,51610,42611,45411,55411,1399,5349,95610,53311,11011,72512,34712,971Import of goods (f.o.b.)12,95615,57016,82917,17816,35214,90415,76316,84518,06219,42720,74122,151Services2,5373,1823,4364,0304,3024,6034,9565,4336,0306,6627,3068,004Of which: Travel1,5751,7471,8842,2252,4912,6692,7792,9183,0823,2483,4083,574Income-745-589-801-1,187-1,739-1,680-1,822-2,028-2,179-2,344-2,524-2,708Current transfers366323333294310312277317341368394422Financial and Capital Account1,9862,5794,4163,1882,2973,2822,8963,0902,7593,0153,2173,463Public sector615681,2391,2431,048703724860768774532782Private sector1,3712,5113,1781,9451,2492,5802,1722,2301,9912,2422,6862,681Foreign direct investment1,4412,1211,9042,3871,9742,1772,4332,6162,8183,0393,2743,546Other private sector flows-703911,274-441-725403-261-386-827-798-588-865Errors and Omissions-144-218101-242-70-525000000Change in International Reserves (increase -)-561-132-2,110-461113-622-500-5000000Current Account -3.4-5.3-5.2-5.0-4.7-4.0-4.2-4.3-4.2-4.3-4.3-4.3Trade balance-9.2-12.2-11.6-11.3-10.5-10.2-10.2-10.4-10.7-11.1-11.3-11.5Export of goods (f.o.b.)25.624.624.623.322.518.017.517.317.116.816.616.2Import of goods (f.o.b.)34.836.836.234.633.028.227.727.727.827.927.927.7Of which: Oil and fuels3.54.84.74.44.22.41.82.02.12.12.02.0Services6.87.57.48.18.78.78.78.99.39.69.810.0Income -2.0-1.4-1.7-2.4-3.5-3.2-3.2-3.3-3.4-3.4-3.4-3.4Current transfers1.00.80.70.60.60.60.50.50.50.50.50.5Financial and Capital account5.36.19.56.44.66.25.15.14.24.34.34.3Of which: Foreign direct investment 3.95.04.14.84.04.14.34.34.34.44.44.4Change in International Reserves (increase -)-1.5-0.3-4.5-0.90.2-1.2-0.9-0.80.00.00.00.0Memorandum Items:Non-oil current account (percent of GDP)0.1-0.5-0.5-0.6-0.5-1.7-2.4-2.3-2.2-2.2-2.3-2.3Terms of trade (annual percentage change)-0.3-3.1-0.80.00.50.70.70.70.70.00.00.0Net international reserves (millions of U.S. dollars) 4,6274,7566,8577,3317,2117,8348,3348,8348,8348,8348,8348,834 -in months of non-maquila imports4.13.95.45.75.65.65.65.65.25.25.25.2 -in percent short-term debt 4/137.5116.4157.9186.7226.0245.0272.7281.3331.1528.6567.9637.4External debt (percent of GDP) 5/25.726.631.935.638.838.436.534.932.630.428.326.2Sources: Central Bank of Costa Rica; and Fund staff estimates.4/ Public and private sector external debt on remaining maturity. Includes trade credit.5/ Includes public and private sector debt.3/ BOP data are reported on a fifth Balance of Payments Manual edition (BPM5) basis, with some differences of presentation relative to the data on a sixth edition (BPM6) basis disseminated by the central bank.2/ Data for 2012-15 reflect new nominal and real GDP data released by the authorities under new statistical standards and new base year 2012. The methodological changes resulted in an upward revision in nominal GDP of about (cid:160)2½ percent in the base year, as a result mainly of a higher share of the rapidly growing services sector. Pending the release of the full new historical GDP series, nominal and real GDP prior to 2012 are staff estimates using new 2012 GDP data by component, and available past growth rates of components under the old standards.1/ Includes cuts in transfers of about 0.4 percent of GDP, another 0.2 percent of GDP of expenditure cuts in a 2016 supplementary budget, broadening of the VAT base and higher taxes on sales of vehicles and real estate from the last quarter of 2016, increase in marginal income tax rates on higher-income brackets from 2017, as well as further amendments to the corporate income tax and moderate gains from improved tax administration.(In percent of GDP)(In millions of U.S. dollars)Projection

Page 46

Table 3a. Costa Rica: Central Government Balance, Baseline Scenario (Partial Adjustment) 1/ 2/

COSTA RICA

INTERNATIONAL MONETARY FUND

Est.201020112012201320142015201620172018201920202021Revenue2,5912,8693,1183,3803,6253,9944,4335,0915,6226,0856,5417,025Tax revenue 2,4922,7693,0083,2923,5223,8624,2904,9375,4565,9066,3486,817Nontax revenue 3/10010011087103132143154166179193207Expenditure 3,6233,7624,1784,7655,2305,6436,1946,8747,5548,2018,8059,349Current noninterest2,7232,9623,3163,6843,9904,3304,5594,8905,2835,7126,1406,599Wages 1,3491,5141,6471,8171,9692,1132,2742,4572,6602,8763,0913,322Goods and services121136143158180194193208225243261281Transfers 1,2521,3131,5261,7081,8422,0232,0912,2252,3992,5932,7872,996Interest 4/4524975306817757871,0271,3031,5111,6681,7821,802Capital449304332400465526608681759821882948Primary balance -580-396-529-704-830-862-733-480-421-448-481-523Overall Balance-1,032-893-1,059-1,386-1,604-1,649-1,761-1,783-1,932-2,116-2,264-2,325Total Financing1,0328931,0591,3861,6041,6491,7611,7831,9322,1162,2642,325External (net)247-112356401490598412417372379247385Domestic (net)7851,0057049841,1151,0511,3491,3661,5601,7372,0171,940Central government debt 5,5626,3828,0158,93210,48411,98413,73215,53217,49019,64021,77024,072External1,1421,0271,3831,7632,3662,9443,3373,7564,1384,5324,6455,006Domestic4,4205,3556,6327,1698,1189,04010,39511,77613,35215,10917,12619,065Revenue13.213.413.313.613.614.114.515.515.915.915.915.9Tax revenue 12.712.912.913.313.213.714.115.115.415.415.415.4Nontax revenue 3/0.50.50.50.40.40.50.50.50.50.50.50.5Expenditure 18.517.617.919.219.620.020.321.021.321.421.421.1Current noninterest13.913.814.214.914.915.314.914.914.914.914.914.9Wages 6.97.17.07.37.47.57.57.57.57.57.57.5Goods and services0.60.60.60.60.70.70.60.60.60.60.60.6Transfers 6.46.16.56.96.97.26.96.86.86.86.86.8Interest 4/2.32.32.32.72.92.83.44.04.34.44.34.1Capital2.31.41.41.61.71.92.02.12.12.12.12.1Primary balance -3.0-1.9-2.3-2.8-3.1-3.0-2.4-1.5-1.2-1.2-1.2-1.2Overall Balance-5.3-4.2-4.5-5.6-6.0-5.8-5.8-5.4-5.5-5.5-5.5-5.3Total Financing5.34.24.55.66.05.85.85.45.55.55.55.3External (net)1.3-0.51.51.61.82.11.41.31.01.00.60.9Domestic (net)4.04.73.04.04.23.74.44.24.44.54.94.4Central government debt 28.429.834.336.039.342.445.047.349.451.352.954.4External5.84.85.97.18.910.410.911.411.711.811.311.3Domestic22.625.028.428.930.432.034.135.937.739.441.643.1Memorandum items:Non-interest expenditure growth (percent) in nominal terms23.13.011.712.09.19.06.47.88.58.17.57.5 in real terms16.5-1.86.96.44.48.15.34.75.35.04.44.3Nominal GDP19,58121,39223,37124,78126,70328,27930,49532,80435,43738,31241,18344,263CPI Inflation (period average)5.74.94.55.24.50.81.13.03.03.03.03.0Sources: Ministry of Finance and Fund staff estimates.3/ Transfers to the Social development and Family Transfers Fund (FODESAF) are recorded in net terms.4/ The inflation adjustment of the principal of TUDES (inflation indexed bonds) was recorded as interest expenditure.2/ Data for 2012-15 reflect new nominal and real GDP data released by the authorities under new statistical standards and new base year 2012. The methodological changes resulted in an upward revision in nominal GDP of about (cid:160)2½ percent in the base year, as a result mainly of a higher share of the rapidly growing services sector. Pending the release of the full new historical GDP series, nominal and real GDP prior to 2012 are staff estimates using new 2012 GDP data by component, and available past growth rates of components under the old standards.1/ Includes cuts in transfers of about 0.4 percent of GDP, another 0.2 percent of GDP of expenditure cuts in a 2016 supplementary budget, broadening of the VAT base and higher taxes on sales of vehicles and real estate from the last quarter of 2016, increase in marginal income tax rates on higher-income brackets from 2017, as well as further amendments to the corporate income tax and moderate gains from improved tax administration.Projection(In billions of colones)(In percent of GDP)

Page 47

COSTA RICA

Table 3b. Costa Rica: Central Government Balance, Full Fiscal Adjustment Scenario 1/ 2/

INTERNATIONAL MONETARY FUND

Est.201020112012201320142015201620172018201920202021Revenue2,5912,8693,1183,3803,6253,9944,4335,2025,9096,3966,8757,383Tax revenue 2,4922,7693,0083,2923,5223,8624,2905,0495,7436,2166,6827,176Nontax revenue 3/10010011087103132143154166179193207Expenditure 3,6233,7624,1784,7655,2305,6436,1696,6497,2047,7788,2528,827Current noninterest2,7232,9623,3163,6843,9904,3304,5594,8215,1425,5205,8936,289Wages 1,3491,5141,6471,8171,9692,1132,2742,4082,5542,7232,8853,057Goods and services121136143158180194193188189205220237Transfers 1,2521,3131,5261,7081,8422,0232,0912,2252,3992,5932,7872,996Interest 4/4524975306817757871,0031,1471,3031,4371,4761,589Capital449304332400465526608681759821882948Primary balance -580-396-529-704-830-862-733-30085499145Overall Balance-1,032-893-1,059-1,386-1,604-1,649-1,736-1,447-1,295-1,383-1,377-1,444Total Financing1,0328931,0591,3861,6041,6491,7361,4471,2951,3831,3771,444External (net)247-112356401490598412417372379247385Domestic (net)7851,0057049841,1151,0511,3241,0309231,0041,1301,059Central government debt 5,5626,3828,0158,93210,48411,98413,70715,17116,49217,90719,15020,570External1,1421,0271,3831,7632,3662,9443,3373,7564,1384,5324,6455,006Domestic4,4205,3556,6327,1698,1189,04010,37011,41512,35413,37514,50615,564Revenue13.213.413.313.613.614.114.515.816.516.416.416.3Tax revenue 12.712.912.913.313.213.714.015.416.116.015.915.9Nontax revenue 3/0.50.50.50.40.40.50.50.50.50.50.50.5Expenditure 18.517.617.919.219.620.020.220.320.120.019.719.5Current noninterest13.913.814.214.914.915.314.914.714.414.214.113.9Wages 6.97.17.07.37.47.57.47.37.17.06.96.8Goods and services0.60.60.60.60.70.70.60.60.50.50.50.5Transfers 6.46.16.56.96.97.26.86.86.76.76.66.6Interest 4/2.32.32.32.72.92.83.33.53.63.73.53.5Capital2.31.41.41.61.71.92.02.12.12.12.12.1Primary balance -3.0-1.9-2.3-2.8-3.1-3.0-2.4-0.90.00.10.20.3Overall Balance-5.3-4.2-4.5-5.6-6.0-5.8-5.7-4.4-3.6-3.6-3.3-3.2Total Financing5.34.24.55.66.05.85.74.43.63.63.33.2External (net)1.3-0.51.51.61.82.11.31.31.01.00.60.9Domestic (net)4.04.73.04.04.23.74.33.12.62.62.72.3Central government debt 28.429.834.336.039.342.444.946.246.146.045.745.5External5.84.85.97.18.910.410.911.411.611.711.111.1Domestic22.625.028.428.930.432.033.934.834.534.434.634.5Memorandum items:Non-interest expenditure growth (percent) in nominal terms23.13.011.712.09.19.06.46.57.37.56.86.8 in real terms16.5-1.86.96.44.48.15.33.44.14.33.73.7Nominal GDP19,58121,39223,37124,78126,70328,27930,54932,83235,78038,89241,94145,177CPI Inflation (period average)5.74.94.55.24.50.81.13.03.03.03.03.0Sources: Ministry of Finance and Fund staff estimates.3/ Transfers to the Social development and Family Transfers Fund (FODESAF) are recorded in net terms.4/ The inflation adjustment of the principal of TUDES (inflation indexed bonds) was recorded as interest expenditure.2/ Data for 2012-15 reflect new nominal and real GDP data released by the authorities under new statistical standards and new base year 2012. The methodological changes resulted in an upward revision in nominal GDP of about (cid:160)2½ percent in the base year, as a result mainly of a higher share of the rapidly growing services sector. Pending the release of the full new historical GDP series, nominal and real GDP prior to 2012 are staff estimates using new 2012 GDP data by component, and available past growth rates of components under the old standards.1/ Includes measures as in the baseline partial adjustment scenario, as well as administratively-determined measures to contain growth in the wage bill, and increases in the VAT rate from 2017.Projection(In billions of colones)(In percent of GDP)

Page 48

Table 4a. Costa Rica: Summary Operations of the Central Government, GFSM 2001

Classification. Baseline Scenario (Partial Adjustment) 1/ 2/

COSTA RICA

INTERNATIONAL MONETARY FUND

Est.201020112012201320142015201620172018201920202021Revenue2,5912,8693,1183,3803,6253,9944,4335,0915,6226,0856,5417,025Taxes2,4922,7693,0083,2923,5223,8624,2904,9375,4565,9066,3486,817Other revenue 3/10010011087103132143154166179193207Expenditure 3,6233,7624,1784,7655,2305,6436,1946,8747,5548,2018,8059,349 Expense3,1743,4593,8464,3654,7655,1175,5866,1936,7947,3807,9228,401Compensation of employees1,3491,5141,6471,8171,9692,1132,2742,4572,6602,8763,0913,322Purchases of goods and services121136143158180194193208225243261281Interest 4/4524975306817757871,0271,3031,5111,6681,7821,802 Of which: Adjustment for TUDES 5048585079-13445158667484Social benefits5065525946166617107668248909621,0341,112Other expense 5/7477619321,0921,1811,3131,3261,4011,5081,6311,7531,884 Net acquisition of nonfinancial assets449304332400465526608681759821882948Gross operating balance-583-589-728-985-1,140-1,124-1,153-1,102-1,172-1,295-1,381-1,376Net lending/borrowing -1,032-893-1,059-1,386-1,604-1,649-1,761-1,783-1,932-2,116-2,264-2,325Net financial transactions1,0328931,0591,3861,6041,6491,7611,7831,9322,1162,2642,325Revenue13.213.413.313.613.614.114.515.515.915.915.915.9Tax revenue 12.712.912.913.313.213.714.115.115.415.415.415.4Nontax revenue 3/0.50.50.50.40.40.50.50.50.50.50.50.5Expenditure 18.517.617.919.219.620.020.321.021.321.421.421.1 Expense16.216.216.517.617.818.118.318.919.219.319.219.0Compensation of employees6.97.17.07.37.47.57.57.57.57.57.57.5Purchases of goods and services0.60.60.60.60.70.70.60.60.60.60.60.6Interest 4/2.32.32.32.72.92.83.44.04.34.44.34.1 Of which: Adjustment for TUDES 0.30.20.20.20.30.00.10.20.20.20.20.2Social benefits2.62.62.52.52.52.52.52.52.52.52.52.5Other expense 5/3.83.64.04.44.44.64.34.34.34.34.34.3 Net acquisition of nonfinancial assets2.31.41.41.61.71.92.02.12.12.12.12.1Gross operating balance-3.0-2.8-3.1-4.0-4.3-4.0-3.8-3.4-3.3-3.4-3.4-3.1Net lending/borrowing -5.3-4.2-4.5-5.6-6.0-5.8-5.8-5.4-5.5-5.5-5.5-5.3Net financial transactions5.34.24.55.66.05.85.85.45.55.55.55.3Memorandum items:Non-interest expenditure growth (percent) in nominal terms23.13.011.712.09.19.06.47.88.58.17.57.5 in real terms16.5-1.86.96.44.48.15.34.75.35.04.44.3Primary balance in billions of colones-580-396-529-704-830-862-733-480-421-448-481-523 in percent of GDP-3.0-1.9-2.3-2.8-3.1-3.0-2.4-1.5-1.2-1.2-1.2-1.2Cyclically-adjusted primary balance (percent of GDP)-3.1-2.0-2.6-2.9-3.0-2.9-2.3-1.4-1.1-1.2-1.2-1.2Fiscal impulse (percent of GDP)1.9-1.00.60.30.1-0.1-0.6-0.9-0.20.00.00.0Nominal GDP19,58121,39223,37124,78126,70328,27930,49532,80435,43738,31241,18344,263CPI Inflation (period average)5.74.94.55.24.50.81.13.03.03.03.03.0Sources: Ministry of Finance and Fund staff estimates.3/ Transfers to the Social development and Family Transfers Fund (FODESAF) are recorded in net terms.4/ The inflation adjustment of the principal of TUDES (inflation indexed bonds) was recorded as interest expenditure.5/ Includes subsidies, transfers and other expense.(In billions of colones)(In percent of GDP)Projection1/ Includes cuts in transfers of about 0.4 percent of GDP, another 0.2 percent of GDP of expenditure cuts in a 2016 supplementary budget, broadening of the VAT base and higher taxes on sales of vehicles and real estate from the last quarter of 2016, increase in marginal income tax rates on higher-income brackets from 2017, as well as further amendments to the corporate income tax and moderate gains from improved anti-tax evasion.2/ Data for 2012-15 reflect new nominal and real GDP data released by the authorities under new statistical standards and new base year 2012. The methodological changes resulted in an upward revision in nominal GDP of about (cid:160)2½ percent in the base year, as a result mainly of a higher share of the rapidly growing services sector. Pending the release of the full new historical GDP series, nominal and real GDP prior to 2012 are staff estimates using new 2012 GDP data by component, and available past growth rates of components under the old standards.

Page 49

COSTA RICA

Table 4b. Costa Rica: Summary Operations of the Central Government, GFSM 2001

Classification. Full Fiscal Adjustment Scenario 1/ 2/

INTERNATIONAL MONETARY FUND

Est.201020112012201320142015201620172018201920202021Revenue2,5912,8693,1183,3803,6253,9944,4455,2105,9206,4326,9297,454Taxes2,4922,7693,0083,2923,5223,8624,3015,0565,7536,2516,7337,244Other revenue 3/10010011087103132143154166181195210Expenditure 3,6233,7624,1784,7655,2305,6436,1766,6407,2187,8308,3318,908 Expense3,1743,4593,8464,3654,7655,1175,5665,9586,4567,0027,4387,946Compensation of employees1,3491,5141,6471,8171,9692,1132,2812,4132,5612,7452,9193,100Purchases of goods and services121136143158180194194189190206223240Interest 4/4524975306817757879921,1261,3011,4351,4761,568 Of which: Adjustment for TUDES 5048585079-13445156616671Social benefits5065525946166617107688268939701,0471,128Other expense 5/7477619321,0921,1811,3131,3301,4041,5131,6441,7741,911 Net acquisition of nonfinancial assets449304332400465526610683761828893962Gross operating balance-583-589-728-985-1,140-1,124-1,121-748-537-570-510-492Net lending/borrowing -1,032-893-1,059-1,386-1,604-1,649-1,731-1,431-1,298-1,398-1,403-1,454Net financial transactions1,0328931,0591,3861,6041,6491,7311,4311,2981,3981,4031,454Revenue13.213.413.313.613.614.114.515.916.516.516.516.5Tax revenue 12.712.912.913.313.213.714.115.416.116.116.116.0Nontax revenue 3/0.50.50.50.40.40.50.50.50.50.50.50.5Expenditure 18.517.617.919.219.620.020.220.220.220.119.919.7 Expense16.216.216.517.617.818.118.218.118.018.017.717.6Compensation of employees6.97.17.07.37.47.57.57.47.27.17.06.9Purchases of goods and services0.60.60.60.60.70.70.60.60.50.50.50.5Interest 4/2.32.32.32.72.92.83.23.43.63.73.53.5 Of which: Adjustment for TUDES 0.30.20.20.20.30.00.10.20.20.20.20.2Social benefits2.62.62.52.52.52.52.52.52.52.52.52.5Other expense 5/3.83.64.04.44.44.64.44.34.24.24.24.2 Net acquisition of nonfinancial assets2.31.41.41.61.71.92.02.12.12.12.12.1Gross operating balance-3.0-2.8-3.1-4.0-4.3-4.0-3.7-2.3-1.5-1.5-1.2-1.1Net lending/borrowing -5.3-4.2-4.5-5.6-6.0-5.8-5.7-4.4-3.6-3.6-3.3-3.2Net financial transactions5.34.24.55.66.05.85.74.43.63.63.33.2Memorandum items:Non-interest expenditure growth (percent) in nominal terms23.13.011.712.09.19.06.76.47.38.17.27.1 in real terms16.5-1.86.96.44.48.15.63.34.24.94.14.0Primary balance in billions of colones-580-396-529-704-830-862-739-30533773114 in percent of GDP-3.0-1.9-2.3-2.8-3.1-3.0-2.4-0.90.00.10.20.3Cyclically-adjusted primary balance (percent of GDP)-3.1-2.0-2.6-2.9-3.0-2.9-2.3-0.80.10.10.20.2Fiscal impulse (percent of GDP)1.9-1.00.60.30.1-0.1-0.6-1.5-0.90.0-0.1-0.1Nominal GDP19,58121,39223,37124,78126,70328,27930,54932,83235,78038,89241,94145,177CPI Inflation (period average)5.74.94.55.24.50.81.13.03.03.03.03.0Sources: Ministry of Finance and Fund staff estimates.3/ Transfers to the Social development and Family Transfers Fund (FODESAF) are recorded in net terms.4/ The inflation adjustment of the principal of TUDES (inflation indexed bonds) was recorded as interest expenditure.5/ Includes subsidies, transfers and other expense.(In billions of colones)(In percent of GDP)Projection1/ Includes measures as in the baseline partial adjustment scenario, as well as administratively-determined measures to contain growth in the wage bill, and increases in the VAT rate from 2017.2/ Data for 2012-15 reflect new nominal and real GDP data released by the authorities under new statistical standards and new base year 2012. The methodological changes resulted in an upward revision in nominal GDP of about (cid:160)2½ percent in the base year, as a result mainly of a higher share of the rapidly growing services sector. Pending the release of the full new historical GDP series, nominal and real GDP prior to 2012 are staff estimates using new 2012 GDP data by component, and available past growth rates of components under the old standards.

Page 50

Table 5a. Costa Rica: Consolidated Public Sector Operations, Baseline Scenario

(Partial Adjustment) 1/ 2/ 3/

COSTA RICA

INTERNATIONAL MONETARY FUND

Est.Controls from Other Tables201020112012201320142015201620172018201920202021Nonfinancial public sector: Revenue4,2584,7155,0365,6276,0216,5297,1067,9668,7289,44310,15010,904Tax revenue 2,5262,8073,0493,3423,5753,9174,3505,0015,5255,9816,4296,904Nontax revenue185225182257259309273293317343368396Social security contributions1,4121,5841,7431,8842,0552,2252,3992,5802,7883,0143,2403,482Operating balance of public enterprises 134996214413278849198106114123Expenditure 4/5,2095,4825,9416,7707,3448,0018,7599,59310,45311,32612,15812,955Current noninterest4,1384,5254,8845,4655,8996,4246,8777,3837,9778,6249,2719,964Wages1,8852,0762,2282,4372,6202,7913,0053,2433,5093,7944,0784,383Goods and services414482514554594643678729788852916984Transfers1,8401,9662,1422,4742,6852,9903,1943,4113,6803,9794,2774,597Interest4324785066607407951,0171,2741,4661,6091,7131,730Of which: Adjustment for TUDES 5/ 2826322742-7242832364146Capital6384805516447057838649351,0101,0921,1741,262Primary balance-519-289-399-483-583-677-636-353-260-274-294-322Overall Balance-951-767-905-1,143-1,323-1,472-1,653-1,627-1,725-1,883-2,007-2,052 Central government-1,032-893-1,059-1,386-1,604-1,649-1,761-1,783-1,932-2,116-2,264-2,325 Decentralized government entities50130193207259224150198248275298315 Public enterprises 31-4-393424-42-42-42-42-42-42-42Total Financing9517679051,1431,3231,4721,6531,6271,7251,8832,0072,052External243-1283384055054794274353903972830Domestic7088955687388189931,2261,1921,3361,4861,7242,052Consolidated public sector: Central Bank balance-88-126-144-195-186-219-231-255-280-305-330-355Consolidated public sector balance-1,039-893-1,049-1,339-1,508-1,687-1,883-1,883-2,006-2,188-2,337-2,407Consolidated public sector debt5,8246,8628,78710,42011,53813,00814,61116,25518,00219,91221,78123,804Nonfinancial public sector: Revenue21.722.021.522.722.523.123.324.324.624.624.624.6Tax revenue 12.913.113.013.513.413.914.315.215.615.615.615.6Nontax revenue0.91.10.81.01.01.10.90.90.90.90.90.9Social security contributions7.27.47.57.67.77.97.97.97.97.97.97.9Operating balance of public enterprises 0.70.50.30.60.50.30.30.30.30.30.30.3Expenditure 4/26.625.625.427.327.528.328.729.229.529.629.529.3Current noninterest21.121.220.922.122.122.722.622.522.522.522.522.5Wages9.69.79.59.89.89.99.99.99.99.99.99.9Goods and services2.12.32.22.22.22.32.22.22.22.22.22.2Transfers9.49.29.210.010.110.610.510.410.410.410.410.4Interest2.22.22.22.72.82.83.33.94.14.24.23.9Of which: Adjustment for TUDES 5/ 0.10.10.10.10.20.00.10.10.10.10.10.1Capital3.32.22.42.62.62.82.82.92.92.92.92.9Primary balance-2.6-1.4-1.7-1.9-2.2-2.4-2.1-1.1-0.7-0.7-0.7-0.7Overall Balance-4.9-3.6-3.9-4.6-5.0-5.2-5.4-5.0-4.9-4.9-4.9-4.6 Central government-5.3-4.2-4.5-5.6-6.0-5.8-5.8-5.4-5.5-5.5-5.5-5.3 Decentralized government entities0.30.60.80.81.00.80.50.60.70.70.70.7 Public enterprises 0.20.0-0.20.10.1-0.1-0.1-0.1-0.1-0.1-0.1-0.1Total Financing4.93.63.94.65.05.25.45.04.94.94.94.6External1.2-0.61.41.61.91.71.41.31.11.00.70.0Domestic3.64.22.43.03.13.54.03.63.83.94.24.6Consolidated public sector: Central Bank balance-0.4-0.6-0.6-0.8-0.7-0.8-0.8-0.8-0.8-0.8-0.8-0.8Consolidated public sector balance-5.3-4.2-4.5-5.4-5.6-6.0-6.2-5.7-5.7-5.7-5.7-5.4Consolidated public sector debt29.732.137.642.043.246.047.949.650.852.052.953.8Consolidated public sector debt, including ICE 33.035.340.745.346.849.651.653.054.054.955.556.2Nominal GDP19,58121,39223,37124,78126,70328,27930,49532,80435,43738,31241,18344,263CPI Inflation (period average)5.74.94.55.24.50.81.13.03.03.03.03.0Sources: Ministry of Finance and Fund staff estimates.4/ Expenditure was adjusted downward in 2010 and upward in 2011 by ½ percent of GDP to reflect a capital project recorded in 2010 but undertaken in 2011.5/ The inflation adjustment of the principal of TUDES (inflation indexed bonds) was recorded as interest expenditure.3/ The consolidated public sector balance comprises the central government, decentralized government entities, public enterprises and the Central Bank, but excludes the Instituto Costarricense de Electricidad (ICE).(In billions of colones)(In percent of GDP)1/ Includes cuts in transfers of about 0.4 percent of GDP, another 0.2 percent of GDP of expenditure cuts in a 2016 supplementary budget, broadening of the VAT base and higher taxes on sales of vehicles and real estate from the last quarter of 2016, increase in marginal income tax rates on higher-income brackets from 2017, as well as further amendments to the corporate income tax and moderate gains from improved anti-tax evasion.Projections2/ Data for 2012-15 reflect new nominal and real GDP data released by the authorities under new statistical standards and new base year 2012. The methodological changes resulted in an upward revision in nominal GDP of about (cid:160)2½ percent in the base year, as a result mainly of a higher share of the rapidly growing services sector. Pending the release of the full new historical GDP series, nominal and real GDP prior to 2012 are staff estimates using new 2012 GDP data by component, and available past growth rates of components under the old standards.

Page 51

COSTA RICA

Table 5b. Costa Rica: Consolidated Public Sector Operations,

Full Fiscal Adjustment Scenario 1/ 2/ 3/

INTERNATIONAL MONETARY FUND

Est.Controls from Other Tables201020112012201320142015201620172018201920202021Nonfinancial public sector: Revenue4,2584,7155,0365,6276,0216,5297,1068,0779,0159,75310,48411,262Tax revenue 2,5262,8073,0493,3423,5753,9174,3505,1135,8126,2916,7627,262Nontax revenue185225182257259309273293317343368396Social security contributions1,4121,5841,7431,8842,0552,2252,3992,5802,7883,0143,2403,482Operating balance of public enterprises 134996214413278849198106114123Expenditure 4/5,2095,4825,9416,7707,3448,0018,7339,37610,11810,92311,63412,456Current noninterest4,1384,5254,8845,4655,8996,4246,8777,3147,8368,4339,0249,654Wages1,8852,0762,2282,4372,6202,7913,0053,1943,4033,6413,8724,118Goods and services414482514554594643678710752813874940Transfers1,8401,9662,1422,4742,6852,9903,1943,4113,6803,9794,2774,597Interest4324785066607407959921,1271,2721,3971,4361,540Of which: Adjustment for TUDES 5/ 2826322742-7242831333639Capital6384805516447057838649351,0101,0921,1741,262Primary balance-519-289-399-483-583-677-636-173169228286346Overall Balance-951-767-905-1,143-1,323-1,472-1,628-1,299-1,103-1,169-1,150-1,193 Central government-1,032-893-1,059-1,386-1,604-1,649-1,736-1,447-1,295-1,383-1,377-1,444 Decentralized government entities50130193207259224150190234256269292 Public enterprises 31-4-393424-42-42-42-42-42-42-42Total Financing9517679051,1431,3231,4721,6281,2991,1031,1691,1501,193External243-1283384055054794274353903972830Domestic7088955687388189931,2018647137728671,193Consolidated public sector: Central Bank balance-88-126-144-195-186-219-231-255-280-305-330-355Consolidated public sector balance-1,039-893-1,049-1,339-1,508-1,687-1,858-1,555-1,383-1,474-1,480-1,548Consolidated public sector debt5,8246,8628,78710,42011,53813,00814,58615,90217,02418,21619,22420,383Nonfinancial public sector: Revenue21.722.021.522.722.523.123.324.625.225.125.024.9Tax revenue 12.913.113.013.513.413.914.215.616.216.216.116.1Nontax revenue0.91.10.81.01.01.10.90.90.90.90.90.9Social security contributions7.27.47.57.67.77.97.97.97.87.77.77.7Operating balance of public enterprises 0.70.50.30.60.50.30.30.30.30.30.30.3Expenditure 4/26.625.625.427.327.528.328.628.628.328.127.727.6Current noninterest21.121.220.922.122.122.722.522.321.921.721.521.4Wages9.69.79.59.89.89.99.89.79.59.49.29.1Goods and services2.12.32.22.22.22.32.22.22.12.12.12.1Transfers9.49.29.210.010.110.610.510.410.310.210.210.2Interest2.22.22.22.72.82.83.23.43.63.63.43.4Of which: Adjustment for TUDES 5/ 0.10.10.10.10.20.00.10.10.10.10.10.1Capital3.32.22.42.62.62.82.82.82.82.82.82.8Primary balance-2.6-1.4-1.7-1.9-2.2-2.4-2.1-0.50.50.60.70.8Overall Balance-4.9-3.6-3.9-4.6-5.0-5.2-5.3-4.0-3.1-3.0-2.7-2.6 Central government-5.3-4.2-4.5-5.6-6.0-5.8-5.7-4.4-3.6-3.6-3.3-3.2 Decentralized government entities0.30.60.80.81.00.80.50.60.70.70.60.6 Public enterprises 0.20.0-0.20.10.1-0.1-0.1-0.1-0.1-0.1-0.1-0.1Total Financing4.93.63.94.65.05.25.34.03.13.02.72.6External1.2-0.61.41.61.91.71.41.31.11.00.70.0Domestic3.64.22.43.03.13.53.92.62.02.02.12.6Consolidated public sector: Central Bank balance-0.4-0.6-0.6-0.8-0.7-0.8-0.8-0.8-0.8-0.8-0.8-0.8Consolidated public sector balance-5.3-4.2-4.5-5.4-5.6-6.0-6.1-4.7-3.9-3.8-3.5-3.4Consolidated public sector debt29.732.137.642.043.246.047.748.447.646.845.845.1Consolidated public sector debt, including ICE 33.035.340.745.346.849.651.451.950.749.748.447.5Nominal GDP19,58121,39223,37124,78126,70328,27930,54932,83235,78038,89241,94145,177CPI Inflation (period average)5.74.94.55.24.50.81.13.03.03.03.03.0Sources: Ministry of Finance and Fund staff estimates.4/ Expenditure was adjusted downward in 2010 and upward in 2011 by ½ percent of GDP to reflect a capital project recorded in 2010 but undertaken in 2011.5/ The inflation adjustment of the principal of TUDES (inflation indexed bonds) was recorded as interest expenditure.3/ The consolidated public sector balance comprises the central government, decentralized government entities, public enterprises and the Central Bank, but excludes the Instituto Costarricense de Electricidad (ICE).(In billions of colones)(In percent of GDP)1/ Includes measures as in the baseline partial adjustment scenario, as well as administratively-determined measures to contain growth in the wage bill, and increases in the VAT rate from 2017.Projections2/ Data for 2012-15 reflect new nominal and real GDP data released by the authorities under new statistical standards and new base year 2012. The methodological changes resulted in an upward revision in nominal GDP of about (cid:160)2½ percent in the base year, as a result mainly of a higher share of the rapidly growing services sector. Pending the release of the full new historical GDP series, nominal and real GDP prior to 2012 are staff estimates using new 2012 GDP data by component, and available past growth rates of components under the old standards.

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Table 6a. Costa Rica: Summary Operations of the Consolidated Public Sector,

GFSM 2001 Classification. Baseline Scenario (Partial Adjustment) 1/ 2/ 3/

COSTA RICA

INTERNATIONAL MONETARY FUND

Est.201020112012201320142015201620172018201920202021Nonfinancial public sector: Revenue4,2584,7155,0365,6276,0216,5297,1067,9668,7289,44310,15010,904Taxes2,5262,8073,0493,3423,5753,9174,3505,0015,5255,9816,4296,904Social contributions1,4121,5841,7431,8842,0552,2252,3992,5802,7883,0143,2403,482Operating balance of public enterprises 134996214413278849198106114123Other revenue185225182257259309273293317343368396Expenditure 5,2095,4825,9416,7707,3448,0018,7599,59310,45311,32612,15812,955 Expense4,5715,0025,3906,1266,6397,2187,8948,6589,44310,23310,98411,694Compensation of employees1,8852,0762,2282,4372,6202,7913,0053,2433,5093,7944,0784,383Purchases of goods and services414482514554594643678729788852916984Interest 4/4324785066607407951,0171,2741,4661,6091,7131,730 Of which: Adjustment for TUDES 2826322742-7242832364146Other expense 5/1,8401,9662,1422,4742,6852,9903,1943,4113,6803,9794,2774,597 Net acquisition of nonfinancial assets6384805516447057838649351,0101,0921,1741,262Gross operating balance-313-287-354-499-618-689-789-692-715-790-833-790Net lending/borrowing (NFPS)-951-767-905-1,143-1,323-1,472-1,653-1,627-1,725-1,883-2,007-2,052Net financial transactions (NFPS)9517679051,1431,3231,4721,6531,6271,7251,8832,0072,052Consolidated public sector : Central Bank balance-88-126-144-195-186-219-231-255-280-305-330-355Net lending/borrowing (consolidated public sector) -1,039-893-1,049-1,339-1,508-1,687-1,883-1,883-2,006-2,188-2,337-2,407Nonfinancial public sector: Revenue21.722.021.522.722.523.123.324.324.624.624.624.6Taxes12.913.113.013.513.413.914.315.215.615.615.615.6Social contributions7.27.47.57.67.77.97.97.97.97.97.97.9Operating balance of public enterprises 0.70.50.30.60.50.30.30.30.30.30.30.3Other revenue0.91.10.81.01.01.10.90.90.90.90.90.9Expenditure 26.625.625.427.327.528.328.729.229.529.629.529.3 Expense23.323.423.124.724.925.525.926.426.626.726.726.4Compensation of employees9.69.79.59.89.89.99.99.99.99.99.99.9Purchases of goods and services2.12.32.22.22.22.32.22.22.22.22.22.2Interest 4/2.22.22.22.72.82.83.33.94.14.24.23.9Other expense 5/9.49.29.210.010.110.610.510.410.410.410.410.4 Net acquisition of nonfinancial assets3.32.22.42.62.62.82.82.92.92.92.92.9Gross operating balance-1.6-1.3-1.5-2.0-2.3-2.4-2.6-2.1-2.0-2.1-2.0-1.8Net lending/borrowing (NFPS)-4.9-3.6-3.9-4.6-5.0-5.2-5.4-5.0-4.9-4.9-4.9-4.6Net financial transactions (NFPS)4.93.63.94.65.05.25.45.04.94.94.94.6Consolidated public sector : Central Bank balance-0.4-0.6-0.6-0.8-0.7-0.8-0.8-0.8-0.8-0.8-0.8-0.8Net lending/borrowing (consolidated public sector) -5.3-4.2-4.5-5.4-5.6-6.0-6.2-5.7-5.7-5.7-5.7-5.4Memorandum items:NFPS non-interest expenditure growth (percent) in nominal terms20.64.88.612.48.19.17.47.58.08.17.57.5 in real terms14.1-0.13.96.83.48.36.34.34.95.07.57.5NFPS primary balance in billions of colones-519-289-399-483-583-677-636-353-260-274-294-322 in percent of GDP-2.6-1.4-1.7-1.9-2.2-2.4-2.1-1.1-0.7-0.7-0.7-0.7Sources: Ministry of Finance and Fund staff estimates.5/ Includes subsidies, transfers and other expense.(In billions of colones)(In percent of GDP)Projection1/ Includes cuts in transfers of about 0.4 percent of GDP, another 0.2 percent of GDP of expenditure cuts in a 2016 supplementary budget, broadening of the VAT base and higher taxes on sales of vehicles and real estate from the last quarter of 2016, increase in marginal income tax rates on higher-income brackets from 2017, as well as further amendments to the corporate income tax and moderate gains from improved anti-tax evasion.3/ The consolidated public sector balance comprises the central government, decentralized government entities, public enterprises and the Central Bank, but excludes the Instituto Costarricense de Electricidad (ICE).4/ The inflation adjustment of the principal of TUDES (inflation indexed bonds) was recorded as interest expenditure.2/ Data for 2012-15 reflect new nominal and real GDP data released by the authorities under new statistical standards and new base year 2012. The methodological changes resulted in an upward revision in nominal GDP of about (cid:160)2½ percent in the base year, as a result mainly of a higher share of the rapidly growing services sector. Pending the release of the full new historical GDP series, nominal and real GDP prior to 2012 are staff estimates using new 2012 GDP data by component, and available past growth rates of components under the old standards.

Page 53

COSTA RICA

Table 6b. Costa Rica: Summary Operations of the Consolidated Public Sector, GFSM 2001

Classification. Full Fiscal Adjustment Scenario 1/ 2/ 3/

INTERNATIONAL MONETARY FUND

Est.201020112012201320142015201620172018201920202021Nonfinancial public sector: Revenue4,2584,7155,0365,6276,0216,5297,1068,0779,0159,75310,48411,262Taxes2,5262,8073,0493,3423,5753,9174,3505,1135,8126,2916,7627,262Social contributions1,4121,5841,7431,8842,0552,2252,3992,5802,7883,0143,2403,482Operating balance of public enterprises 134996214413278849198106114123Other revenue185225182257259309273293317343368396Expenditure 5,2095,4825,9416,7707,3448,0018,7339,37610,11810,92311,63412,456 Expense4,5715,0025,3906,1266,6397,2187,8698,4419,1079,83010,46011,194Compensation of employees1,8852,0762,2282,4372,6202,7913,0053,1943,4033,6413,8724,118Purchases of goods and services414482514554594643678710752813874940Interest 4/4324785066607407959921,1271,2721,3971,4361,540 Of which: Adjustment for TUDES 2826322742-7242831333639Other expense 5/1,8401,9662,1422,4742,6852,9903,1943,4113,6803,9794,2774,597 Net acquisition of nonfinancial assets6384805516447057838649351,0101,0921,1741,262Gross operating balance-313-287-354-499-618-689-763-364-93-772469Net lending/borrowing (NFPS)-951-767-905-1,143-1,323-1,472-1,628-1,299-1,103-1,169-1,150-1,193Net financial transactions (NFPS)9517679051,1431,3231,4721,6281,2991,1031,1691,1501,193Consolidated public sector :Central Bank balance-88-126-144-195-186-219-231-255-280-305-330-355Net lending/borrowing (consolidated public sector) -1,039-893-1,049-1,339-1,508-1,687-1,858-1,555-1,383-1,474-1,480-1,548Nonfinancial public sector: Revenue21.722.021.522.722.523.123.324.625.225.125.024.9Taxes12.913.113.013.513.413.914.215.616.216.216.116.1Social contributions7.27.47.57.67.77.97.97.97.87.77.77.7Operating balance of public enterprises 0.70.50.30.60.50.30.30.30.30.30.30.3Other revenue0.91.10.81.01.01.10.90.90.90.90.90.9Expenditure 26.625.625.427.327.528.328.628.628.328.127.727.6 Expense23.323.423.124.724.925.525.825.725.525.324.924.8Compensation of employees9.69.79.59.89.89.99.89.79.59.49.29.1Purchases of goods and services2.12.32.22.22.22.32.22.22.12.12.12.1Interest 4/2.22.22.22.72.82.83.23.43.63.63.43.4Other expense 5/9.49.29.210.010.110.610.510.410.310.210.210.2 Net acquisition of nonfinancial assets3.32.22.42.62.62.82.82.82.82.82.82.8Gross operating balance-1.6-1.3-1.5-2.0-2.3-2.4-2.5-1.1-0.3-0.20.10.2Net lending/borrowing (NFPS)-4.9-3.6-3.9-4.6-5.0-5.2-5.3-4.0-3.1-3.0-2.7-2.6Net financial transactions (NFPS)4.93.63.94.65.05.25.34.03.13.02.72.6Consolidated public sector :Central Bank balance-0.4-0.6-0.6-0.8-0.7-0.8-0.8-0.8-0.8-0.8-0.8-0.8Net lending/borrowing (consolidated public sector) -5.3-4.2-4.5-5.4-5.6-6.0-6.1-4.7-3.9-3.8-3.5-3.4Memorandum items:NFPS non-interest expenditure growth (percent) in nominal terms20.64.88.612.48.19.17.46.67.27.77.17.0 in real terms14.1-0.13.96.83.48.36.33.54.14.57.17.0NFPS primary balance in billions of colones-519-289-399-483-583-677-636-173169228286346 in percent of GDP-2.6-1.4-1.7-1.9-2.2-2.4-2.1-0.50.50.60.70.8Sources: Ministry of Finance and Fund staff estimates.5/ Includes subsidies, transfers and other expense.(In billions of colones)(In percent of GDP)Projection1/ Includes measures as in the baseline partial adjustment scenario, as well as administratively-determined measures to contain growth in the wage bill, and increases in the VAT rate from 2017.3/ The consolidated public sector balance comprises the central government, decentralized government entities, public enterprises and the Central Bank, but excludes the Instituto Costarricense de Electricidad (ICE).4/ The inflation adjustment of the principal of TUDES (inflation indexed bonds) was recorded as interest expenditure.2/ Data for 2012-15 reflect new nominal and real GDP data released by the authorities under new statistical standards and new base year 2012. The methodological changes resulted in an upward revision in nominal GDP of about (cid:160)2½ percent in the base year, as a result mainly of a higher share of the rapidly growing services sector. Pending the release of the full new historical GDP series, nominal and real GDP prior to 2012 are staff estimates using new 2012 GDP data by component, and available past growth rates of components under the old standards.

Page 54

Table 7. Costa Rica: Public Sector Debt, Baseline Scenario

(Partial Fiscal Adjustment) 1/ 2/

COSTA RICA

INTERNATIONAL MONETARY FUND

Est.201020112012201320142015201620172018201920202021Debt issued by:NFPS & Central Bank (I) 3/7,5748,96111,04312,77414,15915,88817,67119,54221,57223,79525,99328,362 Nonfinancial public sector (NFPS) 3/6,1687,2488,97610,15411,81113,35915,17417,04519,07621,29823,49725,866 Central government5,5626,3828,0158,93210,48411,98413,73215,53217,49019,64021,77024,072 Rest of nonfinancial public sector 3/6058669611,2221,3271,3761,4421,5141,5861,6581,7261,794 Central Bank1,4061,7132,0672,6202,3482,5282,4962,4962,4962,4962,4962,496Intra-public sector debt holdings (II)1,7502,0992,2562,3542,6212,8803,0603,2873,5703,8834,2124,558 CCSS 4/1,1301,3301,3981,4441,6401,8421,9402,0822,2692,4762,7002,933 Other entities of the nonfinancial public sector6047568488999691,0261,1061,1901,2851,3901,4941,606 Central Bank151310111213141516171820Consolidated public sector debt (I-II)5,8246,8628,78710,42011,53813,00814,61116,25518,00219,91221,78123,804 External1,3631,3301,7112,2012,8123,3193,7244,1644,5684,9845,1165,495 Domestic4,4615,5327,0768,2198,7269,68910,88712,09113,43414,92716,66518,309Debt issued by:NFPS & Central Bank (I) 3/38.741.947.251.553.056.257.959.660.962.163.164.1 Nonfinancial public sector (NFPS) 3/31.533.938.441.044.247.249.852.053.855.657.158.4 Central government28.429.834.336.039.342.445.047.349.451.352.954.4 Rest of nonfinancial public sector 3/3.14.04.14.95.04.94.74.64.54.34.24.1 Central Bank7.28.08.810.68.88.98.27.67.06.56.15.6Intra-public sector debt holdings (II)8.99.89.79.59.810.210.010.010.110.110.210.3 CCSS 4/5.86.26.05.86.16.56.46.36.46.56.66.6 Other entities of the nonfinancial public sector3.13.53.63.63.63.63.63.63.63.63.63.6 Central Bank0.10.10.00.00.00.00.00.00.00.00.00.0Consolidated public sector debt (I-II)29.732.137.642.043.246.047.949.650.852.052.953.8 External7.06.27.38.910.511.712.212.712.913.012.412.4 Domestic22.825.930.333.232.734.335.736.937.939.040.541.4Memorandum items:Nominal GDP19,58121,39223,37124,78126,70328,27930,49532,80435,43738,31241,18344,263Sources: Ministry of Finance; and Fund staff estimates.3/ Excludes the debt issued by the Instituto Costarricense de Electricidad (ICE).4/ Caja Costarricense del Seguro Social (social security agency).2/ Data for 2012-15 reflect new nominal and real GDP data released by the authorities under new statistical standards and new base year 2012. The methodological changes resulted in an upward revision in nominal GDP of about (cid:160)2½ percent in the base year, as a result mainly of a higher share of the rapidly growing services sector. Pending the release of the full new historical GDP series, nominal and real GDP prior to 2012 are staff estimates using new 2012 GDP data by component, and available past growth rates of components under the old standards.Projections(In billions of colones)(In percent of GDP)1/ Includes cuts in transfers of about 0.4 percent of GDP, another 0.2 percent of GDP of expenditure cuts in a 2016 supplementary budget, broadening of the VAT base and higher taxes on sales of vehicles and real estate from the last quarter of 2016, increase in marginal income tax rates on higher-income brackets from 2017, as well as further amendments to the corporate income tax and moderate gains from improved anti-tax evasion.

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COSTA RICA

Table 8. Costa Rica: Monetary Survey, Baseline Scenario (Partial Adjustment) 1/ 2/

INTERNATIONAL MONETARY FUND

Est.Proj.Proj.20102011201220132014201520162017Net foreign assets2,4852,5673,6123,7994,0384,4134,7925,195Net international reserves2,3502,4033,4433,6293,8464,1674,4774,793(In millions of U.S. dollars)4,6274,7566,8577,3317,2117,8348,3348,834Net medium-term foreign assets135164170171192000Net domestic assets-1,140-1,067-1,858-1,865-1,902-2,081-2,247-2,420Net domestic credit-926-729-1,303-935-1,019-1,193-1,290-1,400Credit to nonfinancial public sector-288-87-561-201-65-123-123-123Credit to other depository corporations (net)-625-633-733-722-936-1,044-1,141-1,252Credit to other financial corporations (net)-9-7-7-9-16-25-25-25Credit to the private sector (net)-3-2-2-2-2-1-1-1Monetary stabilization instruments (-)-1,252-1,588-1,787-2,492-2,313-2,491-2,491-2,491Other items (net) -319-235-423-326-421-478-778-1,096Capital account (-)1,3571,4851,6551,8871,8502,0812,3122,567Monetary base1,3451,5001,7541,9342,1362,3322,5452,776Currency6657438459219881,0511,1201,198Required reserves6807579091,0131,1471,2811,4251,577Net foreign assets-87-580-1,018-1,534-1,716-2,475-3,507-3,936Net domestic assets8,3899,28710,56511,79713,50514,96116,97118,420Net domestic credit11,89113,17515,26517,24120,07222,68225,60228,754Credit to nonfinancial public sector (net)9801,0011,1481,2251,4931,9862,5883,163Credit to nonfinancial private sector8,6459,83211,14512,50714,70116,44018,43520,646Credit to financial corporations (net)2,2672,3422,9733,5083,8774,2574,5794,946Other items (net)-1,466-1,595-2,097-2,526-3,316-4,093-4,567-5,437Capital account2,0362,2942,6022,9183,2513,6284,0644,897Liabilities to nonfinancial private sector8,3018,7079,54710,26311,78912,48613,46414,483In national currency4,9115,1716,0456,8557,7218,3799,0369,720In foreign currency3,3903,5363,5033,4094,0684,1074,4284,764Of which: Deposits8,0968,4709,3009,98411,48612,15113,36414,651Net foreign assets2,3981,9882,5942,2652,3221,9381,2851,259Net domestic assets7,4788,4278,93710,15812,01213,34415,31716,719Net domestic credit9,33610,74611,73113,53216,12918,30320,90123,686Other items (net)-1,179-1,510-1,847-2,343-2,716-3,412-3,831-4,637Capital account6808099471,0301,4011,5471,7532,330Broad money 9,87510,41511,53012,42414,33415,28216,60217,978Memorandum Items:Monetary base11.211.616.910.210.49.29.19.0Broad money -0.25.510.77.715.46.68.68.3Credit to the private sector4.413.713.412.217.511.812.112.0 Adjusted by changes in the exchange rate8.613.813.712.914.111.912.211.6Monetary base6.97.07.57.88.08.28.38.5Broad money50.448.749.350.153.754.054.454.8 Of which: Deposits denominated in foreign currency17.316.515.013.815.214.514.715.0Credit to the private sector44.146.047.750.555.158.160.562.9 Of which: In foreign currency17.018.119.521.222.524.325.526.0Central bank balance -0.5-0.6-0.7-0.90.1-0.8-0.8-0.8Sources: Central Bank of Costa Rica and Fund staff estimates.2/ Data for 2012-15 reflect new nominal and real GDP data released by the authorities under new statistical standards and new base year 2012. The methodological changes resulted in an upward revision in nominal GDP of about (cid:160)2½ percent in the base year, as a result mainly of a higher share of the rapidly growing services sector. Pending the release of the full new historical GDP series, nominal and real GDP prior to 2012 are staff estimates using new 2012 GDP data by component, and available past growth rates of components under the old standards.1/ Includes cuts in transfers of about 0.4 percent of GDP, another 0.2 percent of GDP of expenditure cuts in a 2016 supplementary budget, broadening of the VAT base and higher taxes on sales of vehicles and real estate from the last quarter of 2016, increase in marginal income tax rates on higher-income brackets from 2017, as well as further amendments to the corporate income tax and moderate gains from improved anti-tax evasion.(In percent of GDP)(Annual percentage change)(In billions of colones, unless otherwise indicated)

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Table 9a. Costa Rica: Medium-Term Framework, Baseline Scenario (Partial Adjustment) 1/ 2/

COSTA RICA

INTERNATIONAL MONETARY FUND

Est.201020112012201320142015201620172018201920202021Real GDP5.04.55.21.83.03.74.24.34.44.34.04.0Domestic demand8.25.65.51.44.14.43.34.65.25.24.74.7 Consumption2.53.58.12.83.44.12.24.14.74.64.14.1 Gross fixed capital formation5.58.98.0-1.22.28.37.16.27.07.06.96.9Exports of goods and nonfactor services6.05.68.12.23.11.9-1.37.15.55.35.05.0Imports of goods and nonfactor services16.78.78.71.16.24.4-2.97.97.67.96.86.8Domestic demand8.15.75.71.44.34.63.54.85.45.55.05.1 Consumption 2.12.96.52.32.93.41.93.53.93.83.43.4 Gross fixed capital formation1.11.71.6-0.20.41.71.51.31.51.61.61.6 Inventory changes 4.91.1-2.5-0.71.0-0.50.20.10.00.10.00.0Net exports -3.2-1.2-0.50.3-1.2-1.00.7-0.6-1.0-1.2-1.0-1.1Savings and InvestmentSavings20.822.020.518.819.619.119.119.319.319.519.719.8Domestic savings17.416.815.313.814.915.114.915.015.015.215.315.5Private sector19.018.116.815.917.217.117.216.816.716.917.017.0Public sector-1.6-1.3-1.5-2.0-2.3-2.1-2.3-1.8-1.7-1.7-1.7-1.5External savings 3/3.45.35.25.04.74.04.24.34.24.34.34.3Gross domestic investment20.822.020.518.819.619.119.119.319.319.519.719.8Private sector 16.617.117.416.216.216.415.815.715.715.715.815.8Public sector3.43.13.23.23.33.43.53.53.53.53.53.5Inventory changes0.81.9-0.1-0.60.1-0.7-0.20.00.10.30.40.4Balance of payments Current account balance-3.4-5.3-5.2-5.0-4.7-4.0-4.2-4.3-4.2-4.3-4.3-4.3Trade balance-9.2-12.2-11.6-11.3-10.5-10.2-10.2-10.4-10.7-11.1-11.3-11.5Services6.87.57.48.18.78.78.78.99.39.69.810.0Income-2.0-1.4-1.7-2.4-3.5-3.2-3.2-3.3-3.4-3.4-3.4-3.4Current transfers1.00.80.70.60.60.60.50.50.50.50.50.5Financial and capital account5.36.19.56.44.66.25.15.14.24.34.34.3Public sector1.70.22.72.52.11.31.31.41.21.10.71.0Private sector3.75.96.83.92.54.93.83.73.13.23.63.4 Foreign direct investment3.95.04.14.84.04.14.34.34.34.44.44.4 Other net private flows-0.20.92.7-0.9-1.50.8-0.5-0.6-1.3-1.1-0.8-1.1Errors and omissions-0.4-0.50.2-0.5-0.1-1.00.00.00.00.00.00.0Change in net international reserves (increase -)-1.5-0.3-4.5-0.90.2-1.2-0.9-0.80.00.00.00.0Memorandum items:Nominal GDP (billions of colones)19,58121,39223,37124,78126,70328,27930,49532,80435,43738,31241,18344,263GDP deflator (percent change)8.04.53.94.24.72.23.43.23.53.73.43.3Consumer prices (percent change; period average)5.74.94.55.24.50.81.13.03.03.03.03.0Consumer prices (percent change; end of period)5.84.74.63.75.1-0.83.03.03.03.03.03.0Credit to the private sector (percent change)4.413.713.412.217.511.812.112.011.611.611.311.2Net international reserves (millions of U.S. dollars)4,6274,7566,8577,3317,2117,8348,3348,8348,8348,8348,8348,834Sources: Central Bank of Costa Rica; and Fund staff estimates.3/ External current account deficit.2/ Data for 2012-15 reflect new nominal and real GDP data released by the authorities under new statistical standards and new base year 2012. The methodological changes resulted in an upward revision in nominal GDP of about (cid:160)2½ percent in the base year, as a result mainly of a higher share of the rapidly growing services sector. Pending the release of the full new historical GDP series, nominal and real GDP prior to 2012 are staff estimates using new 2012 GDP data by component, and available past growth rates of 1/ Includes cuts in transfers of about 0.4 percent of GDP, another 0.2 percent of GDP of expenditure cuts in a 2016 supplementary budget, broadening of the VAT base and higher taxes on sales of vehicles and real estate from the last quarter of 2016, increase in marginal income tax rates on higher-income brackets from 2017, as well as further amendments to the corporate income tax and moderate gains from improved anti-tax evasion.Projections(Annual percentage change)(In percent of GDP)(Contributions to real GDP growth)

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Table 9b. Costa Rica: Medium-Term Framework, Full Fiscal Adjustment Scenario 1/ 2/

INTERNATIONAL MONETARY FUND

Est.201020112012201320142015201620172018201920202021Real GDP5.04.55.21.83.03.74.24.24.64.54.24.3Domestic demand8.25.65.51.44.14.44.84.55.55.44.94.9 Consumption2.53.58.12.83.44.14.03.94.74.94.24.2 Gross fixed capital formation5.58.98.0-1.22.28.37.26.27.06.47.17.1Exports of goods and nonfactor services6.05.68.12.23.11.97.47.45.45.34.94.9Imports of goods and nonfactor services16.78.78.71.16.24.48.67.77.67.56.46.3Domestic demand8.15.75.71.44.34.65.04.75.85.85.35.3 Consumption 2.12.96.52.32.93.43.43.34.04.13.63.5 Gross fixed capital formation1.11.71.6-0.20.41.71.51.31.51.41.61.7 Inventory changes 4.91.1-2.5-0.71.0-0.50.10.10.30.30.10.1Net exports -3.2-1.2-0.50.3-1.2-1.0-0.8-0.5-1.2-1.3-1.0-1.0Savings and InvestmentSavings20.822.020.518.819.619.119.119.320.020.520.720.9Domestic savings17.416.815.313.814.915.114.815.115.916.516.817.2Private sector19.018.116.815.917.217.117.115.815.816.416.716.9Public sector-1.6-1.3-1.5-2.0-2.3-2.1-2.2-0.80.10.00.10.2External savings 3/3.45.35.25.04.74.04.24.24.14.03.83.7Gross domestic investment20.822.020.518.819.619.119.119.320.020.520.720.9Private sector 16.617.117.416.216.216.415.815.715.615.315.315.4Public sector3.43.13.23.23.33.43.53.53.53.53.53.6Inventory changes0.81.9-0.1-0.60.1-0.7-0.20.01.01.71.81.9Balance of payments Current account balance-3.4-5.3-5.2-5.0-4.7-4.0-4.2-4.2-4.1-4.0-3.8-3.7Trade balance-9.2-12.2-11.6-11.3-10.5-10.2-10.2-10.3-10.5-10.6-10.6-10.6Services6.87.57.48.18.78.78.78.99.29.49.69.7Income-2.0-1.4-1.7-2.4-3.5-3.2-3.2-3.3-3.3-3.3-3.3-3.3Current transfers1.00.80.70.60.60.60.50.50.50.50.50.5Financial and capital account5.36.19.56.44.66.25.15.04.14.03.83.7Public sector1.70.22.72.52.11.31.31.41.21.10.71.0Private sector3.75.96.83.92.54.93.83.62.92.93.12.7 Foreign direct investment3.95.04.14.84.04.14.34.34.34.44.44.5 Other net private flows-0.20.92.7-0.9-1.50.8-0.5-0.7-1.4-1.5-1.3-1.8Errors and omissions-0.4-0.50.2-0.5-0.1-1.00.00.00.00.00.00.0Change in net international reserves (increase -)-1.5-0.3-4.5-0.90.2-1.2-0.9-0.80.00.00.00.0Memorandum items:Nominal GDP (billions of colones)19,58121,39223,37124,78126,70328,27930,54932,83235,78038,89241,94145,177GDP deflator (percent change)8.04.53.94.24.72.23.63.14.24.03.43.3Consumer prices (percent change; period average)5.74.94.55.24.50.81.13.03.03.03.03.0Consumer prices (percent change; end of period)5.84.74.63.75.1-0.83.03.03.03.03.03.0Net international reserves (millions of U.S. dollars)4,6274,7566,8577,3317,2117,8348,3348,8348,8348,8348,8348,834Sources: Central Bank of Costa Rica and Fund staff estimates.3/ External current account deficit.2/ Data for 2012-15 reflect new nominal and real GDP data released by the authorities under new statistical standards and new base year 2012. The methodological changes resulted in an upward revision in nominal GDP of about (cid:160)2½ percent in the base year, as a result mainly of a higher share of the rapidly growing services sector. Pending the release of the full new historical GDP series, nominal and real GDP prior to 2012 are staff estimates using new 2012 GDP data by component, and available past growth rates of components under the old standards.1/ Includes measures as in the baseline partial adjustment scenario, as well as administratively-determined measures to contain growth in the wage bill, and increases in the VAT rate from 2017.Projections(Annual percentage change)(In percent of GDP)(Contributions to real GDP growth)

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Table 10. Costa Rica: Banking Sector Indicators 1/

INTERNATIONAL MONETARY FUND

201320142016DecDecDecDecDecDecJanCapitalizationRisk-adjusted capital ratio17.317.316.816.616.716.216.2Capital-to-assets ratio14.815.014.814.514.114.114.2Asset qualityNonperforming loans to total loans1.81.71.71.71.51.61.7Non-income generating assets to total assets17.417.716.817.116.315.615.8Foreclosed assets to total assets0.80.81.01.01.00.90.9Loan loss provisions to total loans1.81.81.71.61.61.92.0ManagementAdministrative expenses to total assets4.34.24.23.93.63.53.5Noninterest expenses to gross income85.076.567.468.177.767.667.4Total expenses to total revenues96.293.190.792.594.292.792.6ProfitabilityReturn on assets (ROA)1.21.31.51.21.21.01.0Return on equity (ROE)8.39.110.38.28.57.37.6Interest margin to gross income16.627.232.130.522.833.533.7LiquidityLiquid assets to total short-term liabilities90.185.192.6101.298.797.898.5Liquid assets to total assets30.728.829.230.429.128.929.0Loans to deposits97.8105.2106.3106.6109.5115.5115.2Liquid assets to deposits43.842.744.047.045.146.646.8Sensitivity to market riskNet open FX position to capital18.818.819.117.817.419.919.9OtherFinancial margin 1/8.28.17.76.87.17.07.0Source: Superintendency of Banks (SUGEF).1/ Difference between implicit loan and deposit rates.Table 10. Costa Rica: Banking Sector Indicators(In percent)2012201020112015

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Annex I. Costa Rica: Financial System Assessment Program (FSAP) Main

Pending Recommendations (2008)

Recommendations

A. Prudential Supervision and Regulation

Comments

Amend the legal framework in order to provide protection

Art. 28 of Insurance Law 8653 of August 7, 2008, provides legal

for supervisors while performing their responsibilities in
good faith.

protection to insurance supervisors. A draft bank resolution law

contemplates protection for bank supervisors participating in

Introduce pertinent laws for the Superintendency of Banks

the resolution process.

A constitutional reform is necessary to establish legal protection

for bank supervisors. CONASSIF has issued agreements to

provide legal assistance to SUGEF senior personnel in case of
judicial inquiries arising from the exercise of their functions.
The draft law that was submitted in the past has been archived

(SUGEF) to be able to supervise banking groups (including

by Congress. SUGEF is in the process of re-drafting a new

offshore structures) on a consolidated basis. Upon the

approval of such laws the SUGEF should issue without delay

operational regulations to ensure their rapid implementation
by the banking system.

reform bill. The strategic orientations of this bill have been
defined in 2015.

Apply higher risk weight ratios to unhedged borrowers for
capital adequacy purposes.

Amendment to capital adequacy regulation took effect in

August 2013. This implemented gradual increases in the

percentages over 18 months, to reach final levels of 125% for

unhedged borrowers and 62.5% for those with residential
mortgages by March 2015. 1
A normative reform that increases the generic provision for un-

hedged borrowers from 0.5 to 1.5 percent is in process.

Approval is expected by May 2016.

Modify the funding arrangements for supervision, in line
with international best practices.
B. Crisis Management and Bank Crisis Resolution Framework

A draft legislation to recapitalize the central bank also
addresses the increase in the financing share of the industry.

Amend article 155 of the Central Bank law in order to grant

With the IMF’s help, SUGEF is in the process of drafting a new

the SUGEF an appropriate range of supervisory tools to

require a bank to take prompt remedial action and to

reform bill. The strategic orientations of this project have been
defined in 2015.

impose penalties in accordance with the gravity of a
situation.

Amend the rating system for prompt corrective actions, to

The authorities intend to amend the rating system once risk-

include new directives that allow the SUGEF to take an

appropriate range of remedial actions and supervisory
decisions.

based supervision is fully in place (currently expected in 2017,
with major reforms to be conducted in 2015 and 2016).1
SUGEF has been carrying pilot visits to various financial entities

which will allow defining the focus of the rating system in the

context of risk-based supervision.

Improve the early warning system, to allow the adoption of
remedial actions in a timely manner.

The authorities will review the possibility of taking a broader
range of remedial actions within the scope of the existing law.

Eliminate the emergency loan window and improve the

The emergency line introduced during the 2008-09 crisis was

design and operational arrangements of the ordinary

discontinued and two high-access rediscount windows were

rediscount window, including by establishing prudential
limits in terms of regulatory capital.

created in 2011: (i) using bonds already included in the money

market collateral pool; and (ii) using commercial credit

portfolio as collateral (with strict rules on quality and haircuts).

Both lines are available in US dollars and in colones. However,

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Recommendations

Comments

the rediscount windows are activated only when a central bank

committee considers that there is a systemic risk; operational

procedures need to be further streamlined; and repo

operations are still to be linked to prudential limits in terms of
regulatory capital

Establish a deposit insurance scheme, in line with
international best practices.
Amend the bank resolution legal framework to include
purchase and assumption type techniques.

SUGEF is working on a draft law with the assistance of the
IMF’s TA.
Improvements to the bank resolution framework are being
developed as a complement to the deposit guarantee scheme.
Approval of the Law on Execution in October 2007 did not
address the weaknesses of the current procedural rules.

Enable voluntary, extra-judicial corporate restructuring
agreements.
1/ Staff’s preliminary assessment based on updated information provided by the authorities.
Source: Superintendence of Financial Institutions.

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Annex II. Costa Rica: Summary of Recommendations in the WHD Cluster

Surveillance Report on Financial Integration in CAPDR

Regulatory

Perimeter

Capital

Adequacy

Corporate

Governance















Credit Limits 




















Regional

Supervision

Macro-

prudential

Regulation

Lender of

Last Resort

Remedial

Actions and

Resolution

Deposit

Insurance

Micro-prudential Regulation

Designate a Lead Supervisor in each country.
Adopt a broad definition of financial conglomerate and economic group.
Develop and periodically update a map of existing financial conglomerates. Empower
supervisors to regulate holding corporations.
Agree on a common scope of supervision to minimize regulatory arbitrage.
Bridge existing different capital definitions across countries.
Adopt common definition of capital consistent with international best practice.
Harmonize the calculation of financial conglomerates’ capital on a consolidated basis.
Adopt common loan classification criteria, at least applicable to regional entities.
Regulate the organization structure of conglomerates to facilitate their supervision.
Reinforce legal authorities for the identification of ultimate ownership of financial
conglomerates and economic groups.
Harmonize regulations on market entry and participation.
Establish minimum regional standards on risk management systems.
Adopt common thresholds on credit concentration and exposures to related parties.
Empower supervisors to inquire about ultimate owners’ identities beyond financial
corporations that are part of the financial conglomerates.
Grant sufficient legal protection to supervisors.

Macro-financial Regulation and Instruments

Implement a Regional Financial Stability Council with a broad mandate for regional
financial stability, building from existing forums and Ministries of Finance.
Extend responsibility of supervising regional conglomerates to principal supervisors.
Harmonize financial data exchange in line with international accounting standards.
Ensure full integration of systemic risk in the regulatory and supervisory frameworks.
Develop national and regional frameworks to identify SIFIs.
Calibrate micro-financial regulatory instruments to address macro-prudential risk.
Agree on a common set of macro-prudential instruments to be used to induce a
reduction of systemic risk from financial conglomerates.
Reinforce regional macro-prudential surveillance, including by regional authorities.
Adopt minimum country requirements on LOLR facilities.
Re-examine regulation for ring-fencing to ensure it addresses liquidity pressures
transmitted across borders through financial conglomerates.
Develop macro-prudential metrics for liquidity in foreign exchange.
Reassess national frameworks on reserve requirements for foreign currency liabilities.
Extend legal regimes for corrective and remedial actions to non-bank financial
institutions, and also specifically for SIFIs and financial conglomerates.
Adapt resolution frameworks to take into account regional implications.

Harmonize deposit insurance facilities.
Establish explicit coverage of deposits in off-shore banks with a specific regime.

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Annex III. Costa Rica: Public Debt Sustainability Analysis

(Higher Scrutiny Case)

The DSA highlights Costa Rica’s unsustainable debt dynamics. The debt stock is projected to rise to

55 percent of GDP by 2021 under the baseline scenario, driven mostly by high fiscal deficits. There are

substantial upside risks to the projected debt path from plausible macro shocks. Risks from relatively

high financing needs are somewhat mitigated by the existence of a stable domestic investor base.

A. Key Assumptions

Debt definition. The public debt sustainability analysis focuses on the central government level

where the worsening of the fiscal situation has taken place in recent years. The rest of the

consolidated public sector has been broadly in balance in recent years as the cash surplus of the

social security system broadly offset the small central bank deficit—resulting from its liquidity
management operations—while public enterprises are broadly in balance.1 The additional
adjustment needed—about 1½ percent of GDP—to close the actuarial deficit that opens up over

the medium and long-term is estimated separately.

Growth and fiscal policy assumptions. The baseline reflects the estimated growth potential of 4

percent. The baseline scenario also assumes fiscal adjustment of about 2¼ of GDP based on the

staff’s assessment of measures already submitted to Congress that have a higher probability of

being approved. The improvement in the primary balance is smaller due to the projected

deterioration in the fiscal position under a passive scenario, driven mostly by increases in

expenditure on education to reach expenditure targets defined under the constitution.

Debt target. In theory it is difficult to justify a unique threshold for debt-to-GDP ratio as the

government is deemed solvent if it can generate future primary surpluses sufficient to service its

outstanding debt. Hence, protracted large budget deficits are not necessarily inconsistent with

sustainability, provided that primary surpluses can be generated in the future. In practice, however,

such an approach may require large future adjustments, which may not be feasible or desirable,

economically and politically. A more operational definition of public debt sustainability offered in

the 2003 WEO suggests that a given public debt level is sustainable if it implies that the

government’s budget constraint (in NPV terms) is satisfied without unrealistically large future

corrections in the primary balance. It also emphasizes the importance of liquidity conditions,

because even if a government satisfies its present value budget constraint, it may not have sufficient

assets and financing available to meet or roll over its maturing liabilities. As practical guidance,

empirical evidence indicates that, for emerging market economies, sustaining a debt-to-GDP ratio

above 50 percent of GDP may be difficult. For example, the WEO (2003) finds that the median public

debt-to-GDP ratio for emerging markets in the year before a default was about 50 percent of

1 The basics output table for the DSA at the consolidated public sector level shows that the estimated sustainability
gap in 2021 is lower than at the central government level, given lower actual and projected primary deficits and
average interest rates at the consolidated level.

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GDP. This study also concludes that, on average, the conduct of fiscal policy in emerging market

economies is not consistent with ensuring sustainability once public debt exceeds a threshold of 50

percent of GDP. Therefore, targeting an upper bound to the public debt ratio below 50 percent of

GDP or so appears justifiable in the case of Costa Rica.

B. Results and Assessment

Results. In the baseline, the headline deficit remains around 5½ percent of GDP in 2021, as the

higher interest bill from rising public debt—which reaches 55 percent of GDP in 2021 and stays on

an upward trajectory thereafter—largely offsets the improvement in the primary balance. The

average gross financing needs would be almost 9 percent of GDP in 2016-21. In the adjustment

scenario, additional measures of 1½ of GDP as part of a gradual but frontloaded consolidation plan

suffice to stabilize debt by 2021 at a level below 50 percent of GDP. This outcome assumes

tightening in credit spreads driven by favorable market reaction to a frontloaded adjustment plan

with credible measures.

Assessment. While most standard indicators are not at “danger” levels (see heat-map), the debt and

gross financing needs approach the benchmarks for medium-risk assessment under stressed

scenarios, and the market perception indicators are approaching the high-risk assessment. In

particular, debt rises above 65 percent of GDP under the combined macro-fiscal shock--compared

to 70 percent benchmark for medium risk in the heat map—with particularly high sensitivity to

growth and fiscal shocks. Debt profile indicators also highlight medium risks from relatively high

spreads on external bonds, with spreads approaching the 600 basis point benchmark for upper risk

assessment.

Mitigating factors. A stable investor base is an important mitigating factor. Notwithstanding the

medium risk ratings for external and FX debt in the debt profile indicators heat map, the share of

these types of debt are at the low end of the reference range for moderate risk countries—external

and FX debt represent less than 25 and 35 percent of total debt, respectively, compared to

benchmark ranges of 15 to 45 for external debt and 20 to 60 for FX debt. Moreover, about 60

percent of domestic debt is held by captive local institutional investors, including the social security

system, nonfinancial public sector institutions, and banks.

INTERNATIONAL MONETARY FUND

Page 64

Costa Rica: Central Government Debt Sustainability Analysis (DSA)––Baseline Scenario

(In percent of GDP unless otherwise indicated)

COSTA RICA

INTERNATIONAL MONETARY FUND 59

As of March 29, 20162/20142015201620172018201920202021Sovereign SpreadsNominal gross public debt30.639.342.445.147.649.651.653.555.0EMBIG (bp) 3/527Public gross financing needs12.510.39.49.59.69.08.08.27.45Y CDS (bp)527Real GDP growth (in percent)4.53.03.74.24.34.44.34.04.0RatingsForeignLocalInflation (GDP deflator, in percent)8.04.72.23.43.23.53.73.43.3Moody'sBa1Ba1Nominal GDP growth (in percent)12.97.85.97.87.68.08.17.57.5S&PsBB-BB-Effective interest rate (in percent) 4/10.78.77.58.69.59.79.59.08.2FitchBB+BB+20142015201620172018201920202021cumulativeChange in gross public sector debt-0.43.23.12.82.42.12.01.91.512.7Identified debt-creating flows-0.33.63.62.72.31.91.81.91.512.1Primary deficit0.13.13.02.41.51.21.21.21.28.6Primary (noninterest) revenue and grants13.913.614.114.515.515.915.915.915.993.6Primary (noninterest) expenditure14.016.717.216.917.017.117.117.117.1102.1Automatic debt dynamics 5/-0.41.10.50.30.80.70.60.70.33.5Interest rate/growth differential 6/-0.60.30.60.30.80.70.60.70.33.5Of which: real interest rate 0.61.32.02.02.62.72.62.72.314.8Of which: real GDP growth-1.3-1.0-1.4-1.7-1.8-1.9-2.0-1.9-2.0-11.3Exchange rate depreciation 7/0.20.8-0.1…………………Other identified debt-creating flows0.1-0.60.10.00.00.00.00.00.00.0Please specify (1) (e.g., drawdown of deposits) (negative)0.1-0.60.10.00.00.00.00.00.00.0Contingent liabilities0.00.00.00.00.00.00.00.00.00.0Please specify (2) (e.g., ESM and Euroarea loans)0.00.00.00.00.00.00.00.00.00.0Residual, including asset changes 8/-0.1-0.4-0.50.10.20.20.20.00.00.6Source: Fund staff estimates and projections.1/ Public sector is defined as central government.2/ Based on available data.3/ EMBIG.4/ Defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.5/ Derived as [(r - π(1+g) - g + ae(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate;a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).6/ The real interest rate contribution is derived from the numerator in footnote 5 as r - π (1+g) and the real growth contribution as -g.7/ The exchange rate contribution is derived from the numerator in footnote 5 as ae(1+r). 8/ Includes asset changes and interest revenues (if any). For projections, includes exchange rate changes during the projection period.9/ Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.0.3balance 9/primaryDebt, Economic and Market Indicators 1/2005-2013ActualProjectionsContribution to Changes in Public DebtProjections2005-2013Actualdebt-stabilizing -8-6-4-20246820052006200720082009201020112012201320142015201620172018201920202021Debt-Creating Flows Primary deficit Real GDP growth Real interest rate Exchange rate depreciation Other debt-creating flows Residual Change in gross public sector debtprojection (in percent of GDP) -15-10-5051015202530cumulative

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COSTA RICA

Costa Rica: Central Government DSA––Composition of Public Debt and Alternative

Scenarios

INTERNATIONAL MONETARY FUND

Baseline Scenario201620172018201920202021Historical Scenario201620172018201920202021Real GDP growth4.24.34.44.34.04.0Real GDP growth4.24.14.14.14.14.1Inflation3.43.23.53.73.43.3Inflation3.43.23.53.73.43.3Primary Balance-2.4-1.5-1.2-1.2-1.2-1.2Primary Balance-2.4-0.9-0.9-0.9-0.9-0.9Effective interest rate8.69.59.79.59.08.2Effective interest rate8.69.59.38.78.06.9Constant Primary Balance ScenarioReal GDP growth4.24.34.44.34.04.0Inflation3.43.23.53.73.43.3Primary Balance-2.4-2.4-2.4-2.4-2.4-2.4Effective interest rate8.69.59.69.49.08.2Source: Fund staff estimates and projections. Underlying Assumptions(in percent)Alternative ScenariosComposition of Public DebtBaselineHistoricalConstant Primary Balance 01020304050607020142015201620172018201920202021Gross Nominal Public Debt(in percent of GDP)projection 02468101220142015201620172018201920202021Public Gross Financing Needs(in percent of GDP)projection 0102030405060200520072009201120132015201720192021By Maturity Medium and long-term Short-termprojection (in percent of GDP) 0102030405060200520072009201120132015201720192021By Currency Local currency-denominated Foreign currency-denominatedprojection (in percent of GDP)

Page 66

Costa Rica: Public DSA––Realism of Baseline Assumptions

COSTA RICA

INTERNATIONAL MONETARY FUND 61

Source: Fund staff estimates and projections.1/ Plotted distribution includes program countries, percentile rank refers to all countries2/ Projections made in the spring WEO vintage of the preceding yearBoom-Bust Analysis 3/3/ Not applicable for Costa Rica, as it meets neither the positive output gap criterion nor the private credit growth criterion.Forecast Track Record, versus program countries -12-10-8-6-4-202468200420052006200720082009201020112012Year 2/Real GDP Growth Interquartile range (25-75) Median Costa Rica forecast error1.6482%Has a percentile rank of:Costa Rica median forecast error, 2004-2012:Distribution of forecast errors: 1/(in percent, actual-projection) -6-4-20246200420052006200720082009201020112012Year 2/Primary Balance Interquartile range (25-75) Median Costa Rica forecast error-0.6039%Has a percentile rank of:Costa Rica median forecast error, 2004-2012:Distribution of forecast errors: 1/(in percent of GDP, actual-projection) -6-4-20246810200420052006200720082009201020112012Year 2/Inflation (Deflator) Interquartile range (25-75) Median Costa Rica forecast error0.8041%Has a percentile rank of:Costa Rica median forecast error, 2004-2012:Distribution of forecast errors: 1/(in percent, actual-projection) pessimistic optimistic -6-4-202468t-5t-4t-3t-2t-1tt+1t+2t+3t+4t+5Real GDP growth Costa…(in percent)Not applicable for Costa Rica pessimistic optimistic pessimistic optimistic

Page 67

COSTA RICA

Costa Rica: Public DSA––Realism of Baseline Assumptions (concluded)

INTERNATIONAL MONETARY FUND

Source: Fund staff estimates and projections.4/ Data cover annual obervations from 1990 to 2011 for advanced and emerging economies with debt greater than 60 percent of GDP. Percent of sample on vertical axis.Assumed multiplier of 1, persistence of 0.6Growth and Level of Output in Absence of Fiscal AdjustmentAssessing the Realism of Projected Fiscal Adjustment -10-505101520253035407075808590951001051101151201251302008201020122014201620182020 Baseline real output Baseline real potential output Implicit real output without adjustmentReal Output Level(Baseline real output in 2016=100) Adjustment (% potential; rhs)projection -10-50510152025303540-12-10-8-6-4-2024682008201020122014201620182020 Baseline real growth Baseline real potential growth Implicit real growth without adjustment(in percent) Adjustment (% potential; rhs)RealGDP Growthprojection 02468101214Less-4.00-3.00-2.00-1.000.001.002.003.004.005.006.007.008.00 Distribution 4/ Costa Rica3-YearAdjustment in Cyclically-Adjusted Primary Balance (CAPB)(Percent of GDP)More3-year CAPBadjustment greater than 3 percent of GDP in approx. top quartile 024681012Less-4.00-3.00-2.00-1.000.001.002.003.004.005.006.007.008.00 Distribution 4/ Costa Rica3-YearAverage Level of Cyclically-Adjusted Primary Balance (CAPB)(Percent of GDP)More

3-year averageCAPB level greater than 3.5 percent of GDP in approx. top quartilehas a percentile rank of31%has a percentile rank of78%

Page 68

Costa Rica: Central Government DSA––Stress Tests

COSTA RICA

INTERNATIONAL MONETARY FUND 63

Primary Balance Shock201620172018201920202021Real GDP Growth Shock201620172018201920202021Real GDP growth4.24.34.44.34.04.0Real GDP growth4.21.41.54.34.04.0Inflation3.43.23.53.73.43.3Inflation3.42.52.83.73.43.3Primary balance-2.4-2.8-2.5-1.2-1.2-1.2Primary balance-2.4-2.1-2.4-1.2-1.2-1.2Effective interest rate8.69.59.79.59.18.3Effective interest rate8.69.59.79.59.18.3Real Interest Rate ShockReal Exchange Rate ShockReal GDP growth4.24.34.44.34.04.0Real GDP growth4.24.34.44.34.04.0Inflation3.43.23.53.73.43.3Inflation3.47.03.53.73.43.3Primary balance-2.4-1.5-1.2-1.2-1.2-1.2Primary balance-2.4-1.5-1.2-1.2-1.2-1.2Effective interest rate8.69.510.110.19.89.2Effective interest rate8.69.99.69.49.08.2Combined ShockReal GDP growth4.21.41.54.34.04.0Inflation3.42.52.83.73.43.3Primary balance-2.4-2.8-2.5-1.2-1.2-1.2Effective interest rate8.69.99.910.09.89.2Source: Fund staff estimates and projections.Macro-Fiscal Stress TestsBaselinePrimary Balance ShockReal GDP Growth ShockReal Interest Rate Shock(in percent)Real Exchange Rate ShockCombined Macro-Fiscal ShockAdditional Stress TestsBaselineUnderlying Assumptions 010203040506070201620172018201920202021Gross Nominal Public Debt(in percent of GDP) 050100150200250300350400450201620172018201920202021Gross Nominal Public Debt(in percent of Revenue) 024681012201620172018201920202021Public Gross Financing Needs(in percent of GDP) 010203040506070201620172018201920202021Gross Nominal Public Debt(in percent of GDP) 200250300350400450201620172018201920202021Gross Nominal Public Debt(in percent of Revenue) 02468101214201620172018201920202021Public Gross Financing Needs(in percent of GDP)

Page 69

COSTA RICA

Costa Rica: Central Government DSA Risk Assessment

INTERNATIONAL MONETARY FUND

Costa RicaSource: Fund staff estimates and projections.5/ External financing requirement is defined as the sum of current account deficit, amortization of medium and long-term total external debt, and short-term total external debt at the end of previous period.4/ EMBIG, an average over the last 3 months, 30-Dec-15 through 29-Mar-16.2/ The cell is highlighted in green if gross financing needs benchmark of 15% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.200 and 600 basis points for bond spreads; 5 and 15 percent of GDP for external financing requirement; 0.5 and 1 percent for change in the share of short-term debt; 15 and 45 percent for the public debt held by non-residents; and 20 and 60 percent for the share of foreign-currency denominated debt.Market PerceptionDebt level 1/Real GDP Growth ShockPrimary Balance Shock3/ The cell is highlighted in green if country value is less than the lower risk-assessment benchmark, red if country value exceeds the upper risk-assessment benchmark, yellow if country value is between the lower and upper risk-assessment benchmarks. If data are unavailable or indicator is not relevant, cell is white. Lower and upper risk-assessment benchmarks are:Change in the Share of Short-Term DebtForeign Currency DebtPublic Debt Held by Non-ResidentsPrimary Balance ShockReal Interest Rate ShockExchange Rate ShockContingent Liability ShockExchange Rate ShockContingent Liability shock1/ The cell is highlighted in green if debt burden benchmark of 70% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.Real Interest Rate ShockExternal Financing RequirementsReal GDP Growth ShockHeat MapUpper early warningEvolution of Predictive Densities of Gross Nominal Public Debt(in percent of GDP)Debt profile 3/Lower early warning(Indicators vis-à-vis risk assessment benchmarks, in 2015) Debt Profile VulnerabilitiesGross financing needs 2/ 206035%12 200600470 bp12 51511%12 0.510.1%12EMBIGExternal Financing RequirementAnnual Change in Short-Term Public DebtPublic Debt in Foreign Currency(in basis points) 4/(in percent of GDP) 5/(in percent of total)(in percent of total) 0102030405060708020142015201620172018201920202021 10th-25th 25th-75th 75th-90thPercentiles: BaselineSymmetric Distribution 0102030405060708020142015201620172018201920202021Restricted (Asymmetric) Distributionno restriction on the growth rate shockno restriction on the interest rate shock0 is the max positive pb shock (percent GDP)no restriction on the exchange rate shockRestrictions on upside shocks: 154525%12Public Debt Held by Non-Residents(in percent of total)

Page 70

Costa Rica: Consolidated Public Sector Debt Sustainability Analysis (DSA)––Baseline Scenario

(In percent of GDP unless otherwise indicated)

COSTA RICA

INTERNATIONAL MONETARY FUND 65

As of March 29, 20162/20142015201620172018201920202021Sovereign SpreadsNominal gross public debt34.443.246.048.951.453.455.357.158.5EMBIG (bp) 3/527Public gross financing needs5.010.010.110.09.99.38.28.47.65Y CDS (bp)527Real GDP growth (in percent)4.53.03.74.24.34.44.34.04.0RatingsForeignLocalInflation (GDP deflator, in percent)8.04.72.23.43.23.53.73.43.3Moody'sBa1Ba1Nominal GDP growth (in percent)12.97.85.97.87.68.08.17.57.5S&PsBB-BB-Effective interest rate (in percent) 4/8.87.16.97.88.58.78.58.17.4FitchBB+BB+20142015201620172018201920202021cumulativeChange in gross public sector debt-1.01.22.82.92.52.01.91.81.512.6Identified debt-creating flows-0.53.84.12.82.31.81.71.81.512.0Primary deficit0.02.93.22.81.91.51.51.51.510.8Primary (noninterest) revenue and grants22.122.523.123.324.324.624.624.624.6146.1Primary (noninterest) expenditure22.125.426.226.126.126.226.226.226.2156.9Automatic debt dynamics 5/-1.10.70.30.00.40.30.20.3-0.11.2Interest rate/growth differential 6/-1.4-0.30.40.00.40.30.20.3-0.11.2Of which: real interest rate 0.10.91.91.82.42.42.32.42.113.3Of which: real GDP growth-1.5-1.2-1.5-1.8-1.9-2.1-2.1-2.1-2.1-12.1Exchange rate depreciation 7/0.31.0-0.1…………………Other identified debt-creating flows0.50.20.70.00.00.00.00.00.00.0Please specify (1) (e.g., drawdown of deposits) (negative)0.50.20.70.00.00.00.00.00.00.0Contingent liabilities0.00.00.00.00.00.00.00.00.00.0Please specify (2) (e.g., ESM and Euroarea loans)0.00.00.00.00.00.00.00.00.00.0Residual, including asset changes 8/-0.4-2.6-1.30.10.20.20.20.00.00.6Source: Fund staff estimates and projections.1/ Public sector is defined as consolidated public sector.2/ Based on available data.3/ EMBIG.4/ Defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.5/ Derived as [(r - π(1+g) - g + ae(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate;a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).6/ The real interest rate contribution is derived from the numerator in footnote 5 as r - π (1+g) and the real growth contribution as -g.7/ The exchange rate contribution is derived from the numerator in footnote 5 as ae(1+r). 8/ Includes asset changes and interest revenues (if any). For projections, includes exchange rate changes during the projection period.9/ Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.-0.1balance 9/primaryDebt, Economic and Market Indicators 1/2005-2013ActualProjectionsContribution to Changes in Public DebtProjections2005-2013Actualdebt-stabilizing -12-10-8-6-4-20246820052006200720082009201020112012201320142015201620172018201920202021Debt-Creating Flows Primary deficit Real GDP growth Real interest rate Exchange rate depreciation Other debt-creating flows Residual Change in gross public sector debtprojection (in percent of GDP) -15-10-5051015202530cumulative

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COSTA RICA

Annex IV. Costa Rica: External Debt Sustainability Analysis

INTERNATIONAL MONETARY FUND

Est.201320142015201620172018201920202021Debt-stabilizingnon-interest current account 6/Baseline: External debt35.638.838.436.534.932.630.428.326.2-4.8Change in external debt3.73.2-0.4-1.9-1.5-2.4-2.2-2.1-2.10.0Identified external debt-creating flows (4+8+9)-2.40.3-2.9-3.2-2.8-2.8-2.6-2.5-2.50.0Current account deficit, excluding interest payments4.23.73.03.23.23.13.23.23.34.8Deficit in balance of goods and services3.21.80.00.00.0-0.10.00.00.0Exports35.535.332.231.631.731.731.831.731.5Imports 38.737.232.231.731.731.731.831.731.5Net non-debt creating capital inflows (negative)-5.4-4.4-4.5-4.7-4.7-4.7-4.8-4.8-4.8-4.8Automatic debt dynamics 1/-1.21.0-1.4-1.7-1.3-1.2-1.0-0.9-0.90.0Contribution from nominal interest rate0.81.01.01.01.01.11.11.11.11.0Contribution from real GDP growth -0.5-1.1-1.3-1.5-1.5-1.4-1.3-1.1-1.1-1.0Contribution from price and exchange rate changes 2/ -1.5……………………Residual, incl. change in gross foreign assets (2-3) 3/6.02.92.51.31.20.40.40.40.40.0External debt-to-exports ratio (in percent)100.3109.8119.2115.4110.3102.695.689.383.3Gross external financing need (in billions of US dollars) 4/6.86.35.85.85.85.85.84.95.0in percent of GDP13.812.610.910.29.59.08.46.66.3Scenario with key variables at their historical averages 5/34.932.429.426.523.821.3-6.6For debtKey Macroeconomic Assumptions Underlying BaselinestabilizationReal GDP growth (in percent)1.83.03.74.24.34.44.34.04.04.0GDP deflator in US dollars (change in percent)4.9-2.82.93.22.42.52.72.93.33.3Nominal external interest rate (in percent)2.82.82.82.83.03.43.83.94.04.0Growth of exports (US dollar terms, in percent)3.9-0.5-2.75.66.97.27.26.86.7Growth of imports (US dollar terms, in percent)1.7-4.0-7.75.96.77.17.46.76.8Current account balance, excluding interest payments -4.2-3.7-3.0-3.2-3.2-3.1-3.2-3.2-3.3Net non-debt creating capital inflows 5.44.44.54.74.74.74.84.84.8Source: National authorities and Fund staff estimates.1/ Derived as [r - g - r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.2/ The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator). 3/ For projection, line includes the impact of price and exchange rate changes.4/ Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period. 5/ The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.6/ Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.Actual Projections

Page 72

Costa Rica: External Debt Sustainability––Bound Tests 1/ 2/

(External debt in percent of GDP)

COSTA RICA

INTERNATIONAL MONETARY FUND 67

i-rate shock27.2Baseline26.21520253035404550552009201120132015201720192021Interest rate shock (in percent)Sources: International Monetary Fund, Country desk data, and staff estimates.1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown. 2/ For historical scenarios, the historical averages are calculated over the ten-year period, and the information is used to project debt dynamics five years ahead.3/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.4/ One-time real depreciation of 30 percent occurs in 2016. Historical21Baseline26.205101520253005101520253035404550552009201120132015201720192021Baseline and historical scenarios CA shock 32.0Baseline26.2152025303540452009201120132015201720192021 Combined shock 30.4Baseline26.2152025303540452009201120132015201720192021Combined shock 3/ 30 % depreciation39.3Baseline26.21520253035404550552009201120132015201720192021Real depreciation shock 4/ Gross financing need under baseline(right scale) Non-interest current account shock (in percent of GDP) Growth shock 27.6Baseline26.2152025303540452009201120132015201720192021Growth shock (in percent per year) Baseline: Scenario: Historical: 3.4 3.8 3.9 Baseline: Scenario: Historical: 4.1 2.7 4.5 Baseline: Scenario: Historical: -3.2 -4.1 -3.9

Page 73

April 20, 2016

COSTA RICA

STAFF REPORT FOR THE 2016 ARTICLE IV

CONSULTATION—INFORMATIONAL ANNEX

Prepared By:

The Western Hemisphere Department

CONTENTS

FUND RELATIONS ___________________________________________________________________________ 2

PAST FUND STAFF RECOMMENDATIONS AND IMPLEMENTATION ______________________ 4

RELATIONS WITH THE WORLD BANK AND BANK-FUND COLLABORATION UNDER

THE JOINT MANAGEMENT ACTION PLAN (JMAP) ________________________________________ 6

RELATIONS WITH THE INTER-AMERICAN DEVELOPMENT BANK ________________________ 9

STATISTICAL ISSUES _______________________________________________________________________ 11

Page 74

SDR Million
369.40
298.07
71.34

SDR Million
156.53
85.09

% Quota
100.00
80.69
19.31

% Allocation

100.00
54.36

0.00
0.00
0.00

COSTA RICA

FUND RELATIONS

(As of February 29, 2016)

Membership Status: Joined: January 8, 1946

General Resources Account:

Quota
Fund holdings of currency
Reserve Tranche Position

SDR Department:

Net cumulative allocation

Holdings

Outstanding Purchases and Loans:

None

Latest Financial Arrangements:

Date of

Expiration

Amount
Approved

Amount Drawn

Date

(SDR Million)

Type

Stand-By

Stand-By
Stand-By

Arrangement
04/11/2009
11/29/1995
04/19/1993

07/10/2010
02/28/1997
02/18/1994

492.30
52.00
21.04

Projected Payments to Fund
(SDR Million; based on existing use of resources and present holdings of SDRs):

Principal
Charges/Interest
Total

Overdue

Forthcoming

0.00

2016

2017

2018

2019

0.00

0.03

0.00

0.05

0.00

0.05

0.00

0.05

Exchange Rate Arrangement. Costa Rica’s de jure current exchange rate arrangement classification

is “managed float,” (previously classified as a crawling band arrangement) while the de facto current

exchange rate arrangement is classified as “stabilized.” The former was established on February 2,

2015. The central bank committed to allow the exchange rate to be freely determined by foreign

currency supply and demand, but reserved the right to participate in the market in order to meet its

own foreign currency requirements and those of the nonbank public sector and, at its discretion, to

prevent sharp fluctuations in the exchange rate. In 2015, the exchange rate deviated less than 1

percent from its mean value against the U.S. dollar, mostly because the Central Bank maintained

2 INTERNATIONAL MONETARY FUND

Page 75

COSTA RICA

significant active role in exchange rate management to avert excessive volatility in light of the large

financial dollarization of the financial system. Costa Rica maintains an exchange system free of

restrictions on the making of payments and transfers for current international transactions.

Article IV Consultation. The last Article IV consultation was concluded on January 31, 2015

(Country Report No. 15/29).

FSAP participation and ROSCs. The FSAP took place in 2001, and was updated in 2008. A data

ROSC took place in 2001 with a reassessment in 2009. A fiscal ROSC took place in 2006.

Technical Assistance.

Department

Time of Delivery

Purpose

STA, CAPTAC-DR

Real Sector

External Sector

November 2014
January 2015
February 2015
March 2015
May 2015
May 2015
July 2015
August 2015
August 2015
December 2015

February 2015
March 2015
August 2015
September 2015

Quarterly national accounts
Source data – quarterly construction survey
Quarterly national accounts
Financial account – flow of funds table
Quarterly national accounts
National accounts – projections with I-O tables indices
National accounts – source data (survey and directories)
Quarterly national accounts
Annual national accounts (agriculture)
Quarterly national accounts

Balance of payments statistics and IIP
Topics of the financial account
Balance of payments statistics – external debt
Balance of payments and IIP statistics

MCM, CAPTAC-DR November 2014
November 2014
January 2015
January 2015
March 2015
March 2015
April 2015
April 2015
April 2015
April 2015
May 2015
July 2015
July 2015
August 2015
August 2015
September 2015
September 2015
October 2015
November 2015
November 2015
January 2016
January 2016
February 2016
February 2016
March 2016
March 2016
March 2016

Macroeconomic analysis and projection
Capacity building of the division of financial stability
Building a model to analyze regional policy transmission mechanisms
Implementation of risk-based securities supervision
Improve operational framework of exchange rate policy
Minimum capital requirements for market risk
Implementation of risk-based securities supervision
Corporate governance
Capital market risk
Development model dynamic stochastic general equilibrium
Monetary and exchange rate policy
Capacity building of regional convergence analysis
Corporate governance follow-up
Bank supervision & regulations
Regulation of liquidity risk
Capacity building for financial stability analysis
Regulation and supervision of credit risk
Interest rates behavior and financial sector demand for medium-term government
Banking supervision
Regulation and supervision of credit risk
Accounting standardization
Improve capabilities for analyzing financial stability/stress testing
Macroprudential
Capacity building projection and macroeconomic analysis of BCCR
Strengthening capacities for macroeconomic analysis-Central American
Regulation and supervision of credit risk
Corporate governance – review of draft rules and laws

INTERNATIONAL MONETARY FUND 3

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COSTA RICA

FAD, CAPTAC-DR

LEG

November 2014
January 2015
February 2015
February 2015
February 2015
April 2015
April 2015
June 2015
June 2015
August 2015
August 2015
October 2015
October 2015
November 2015
February 2016
March 2016
March 2016

September 2014
November 2014
December 2014
March 2015
May 2015
July 2015
September 2015

Customs administration
Tax Administration
Tax Administration
Public financial management
Customs administration
Customs administration
Tax administration
Paper “Grado de madurez”
Customs administration
Custom administration
Strengthening the integral IVA credit
Management indicators
Customs administration
Improvement of mass audit implementation
Customs administration
Information crossed
Matrix risk construction

Formulate a National AML/CFT Strategy
Formulate a National AML/CFT Strategy
Formulate a National AML/CFT Strategy
Formulate a National AML/CFT Strategy
Formulate a National AML/CFT Strategy
Formulate a National AML/CFT Strategy
Deposit Insurance Scheme and Banking Resolution

Resident Representative: Mario Garza (based in Guatemala) is the regional resident representative

for Central America, Panama and the Dominican Republic.

PAST FUND STAFF RECOMMENDATIONS AND
IMPLEMENTATION

2014 Article IV Staff Recommendation

Implementation

 Fiscal adjustment of 3¾ percent of GDP is

 In 2015, the new administration that came into

Fiscal Policy

needed to stabilize the debt-to-GDP ratio over
the medium term below levels which are shown
to pose risks for macro stability in emerging
markets. In the longer-term, parametric
adjustments would also be needed to remedy the
actuarial imbalance of the pension system.

 Start fiscal adjustment in 2015 as a first critical
step to reduce the sustainability gap, while also
mitigating risks of higher inflation, widening
external imbalances and possible adverse
financial market reactions.

power in mid-2014 presented tax and expenditure
reform proposals to Congress that could yield about
2¾ percent of GDP, although none of the measures
have yet obtained Congressional approval. The
administration has also identified administratively-
determined expenditure cuts that would yield the
additional 1 percent of GDP needed to fully close
the sustainability gap. The authorities have also
started to take measures to remedy the actuarial
imbalance of the pensions system, including the
elimination of the early retirement option, and are
considering raising minimum contributions and
gradually raising contribution rates over the medium
term.

 The new administration has maintained a broadly

4 INTERNATIONAL MONETARY FUND

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COSTA RICA

unchanged non-interest deficit, with efforts to
restrain spending and reduce tax evasion preventing
a budgeted deterioration in the primary balance of
more than ½ percent of GDP in 2014-15.

Monetary and Foreign Exchange Policy

 Stand ready to raise rates if inflation does not
decline to the target range once pass-through
from exchange rate depreciation in the first half
of 2014 is completed.

 Allow more XR flexibility to help establish

inflation as the undisputed monetary anchor, as
well as to discourage dollarization. Take
advantage of current absence of pressures on the
exchange rate to abandon the XR band.
Continued FX intervention to reduce volatility
and strengthen the NIR position can be
warranted as long as inflation target is not
jeopardized. Improve transparency of the FX-
intervention-rule.

 Inflation declined sharply to -1¼ percent toward the

end of 2015, from almost 6 percent a year earlier,
driven by low oil prices. The authorities reacted by
adopting an appropriately accommodative stance
with policy rate cuts of 350 basis points to 1¾
percent. The central bank took advantage of the fall
in inflation to lower the target range to 2-4 percent,
in line with average inflation of trading partners.

 The authorities removed the XR band in early 2015
in line with Fund advice, while maintaining their FX
intervention policy, including an undisclosed rule to
dampen volatility and a general policy of preventing
excessive deviations from fundamentals.

 A lower current account deficit from lower oil prices,

continued Eurobond issuance, resilient FDI, and
increase net foreign bank liabilities resulted in
strong reserve accumulation during 2015, in line
with the authorities’ FX purchase program, while the
exchange rate remained stable.

 Implementation of the 2008 FSAP

 Progress on introducing FSAP recommendations has

Financial Sector

recommendations should be accelerated.

 The authorities should strive to introduce risk-
based supervision and improve supervision of
cross-border financial operations. Existing capital
quality should be firmed up and liquidity and
capital requirements increased in line with Basel
III standards.

 Reduce vulnerabilities stemming from currency
mismatches in the private sector and high bank
net foreign liabilities.

been mixed. Critical legislation to enhance
consolidated supervision and strengthen bank
resolution remains to be approved.

 Measures have been enacted to move towards full
implementation of risk-based supervision. Basel III
Liquidity Coverage Ratio was introduced in 2015.

 Capital risk-weightings on FX loans to unhedged

borrowers have been increased, and reserve
requirements were extended to medium- and long-
term foreign bank borrowing (in addition to the
existing requirement on short-term foreign
borrowing). Additional measures are currently under
consideration, including: (i) stricter provisioning on
FX loans to unhedged borrowers and household
debt with income-to-debt service ratios above 30
percent; (ii) counter-cyclical provisioning; and (iii)
higher risk-weightings for household mortgages
with high loan-to-value and income-to-debt service
ratios.

INTERNATIONAL MONETARY FUND 5

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COSTA RICA

RELATIONS WITH THE WORLD BANK AND BANK-

FUND COLLABORATION UNDER THE JOINT

MANAGEMENT ACTION PLAN (JMAP)

1. The IMF’s Costa Rica team led by Mr. Figliuoli (mission chief) has met on various
occasions with the World Bank’s Costa Rica team led by Mr. Calvo-Gonzalez (lead economist

and PREM sector leader) to discuss macroeconomic challenges, identify macro-critical structural
reforms, and coordinate the two teams’ work.

2. The teams agreed that Costa Rica’s main macroeconomic challenges are to safeguard

fiscal sustainability, increase the effectiveness of monetary policy, maintain financial sector

stability and enhance competitiveness.

3. Based on the shared assessment of macroeconomic challenges, the teams identified

four structural reform areas as macro-critical:



Fiscal consolidation. The fiscal consolidation strategy should comprise both revenue and

expenditure components, with a slant towards revenue enhancement. The adjustment plan

laid out by the authorities is appropriate, but full implementation is critical. Key elements

include raising revenues through fiscal reforms already submitted to Congress that

adequately focus on broadening the base for the VAT, increasing VAT rates and marginal

income tax rates on high earners, with an additional sizeable contribution from mostly

administratively-determined measures aimed at gradually reducing expenditures as a share

of GDP.



Monetary policy framework. The transition to inflation targeting and greater exchange rate

flexibility should be accelerated in order to lock in low inflation achieved in recently years.

Financial sector stability. Progress has been made in adopting risk-based financial

supervision. Looking ahead, approval of legislation on consolidated supervision, deposit

insurance and banking resolution will be critical to bring the regulatory framework up to

international best practices.



Productivity. The country is making progress in addressing issues of universal coverage and

quality in secondary education, and is seeking to develop its scientific and technological

capabilities, which would help maintain Costa Rica’s growth of knowledge-intensive exports.

There is also strong commitment to improving the business environment and removing

burdensome red tape. Given the sizable investments required to upgrade infrastructure and

the tight fiscal situation, the government is seeking to create the institutional conditions to

engage the private sector in financing, construction and management of infrastructure

projects (public-private partnerships), though these will require vigilance to avoid undue

contingent liabilities.

6 INTERNATIONAL MONETARY FUND

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COSTA RICA

4. The teams agreed the following division of labor:



Fiscal consolidation. The IMF (the Fund) will continue to provide policy recommendations on

macro-fiscal issues, including the overall strategy of fiscal consolidation and the tax reform.

The World Bank (the Bank) will seek opportunities to provide technical assistance to support

the use of public-private partnerships as a vehicle to finance key infrastructure projects. The

government also requested assistance to improve financial management, service delivery,

and sustainability of its social security system.



Monetary policy framework. The Fund will continue to provide policy recommendations

regarding the transition to inflation targeting and a more flexible exchange rate regime.

Financial sector stability. The Bank and the Fund will cooperate as necessary in assisting the

country in implementing the FSAP recommendations. The authorities have requested an

FSAP update for next fiscal year.



Productivity. The Bank will continue to provide policy recommendations in key areas. In

terms of lending, the government is being supported by a project in higher education

(approved in September 2012), a catastrophe draw down deferred option (approved in

March 2009) and a health operation (approved in March 2016). The government has also

requested technical assistance from IFC Advisory services to improve the investment climate.

5. The teams have the following requests for information from their counterparts:



The Fund team requests to be kept informed of progress in the above macro-critical

structural reform areas. Timing: when milestones are reached (and at least semi-annually).

The Bank team requests to be kept informed of the Fund’s assessments of macroeconomic

policies and prospects. Timing: when milestones are reached (and at least semi-annually).

INTERNATIONAL MONETARY FUND 7

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COSTA RICA

6. The table below lists the teams’ separate and joint work programs for 2015.

Table 1. World Bank and IMF Planned Activities in Macro-Critical Structural Reform Areas

Title

Products

Provisional Timing

Expected Delivery

of Missions

Date

World Bank Work

Good Practices in Development

Program

Finance

Completed (final

delivery March 2016)

Fiscal Management in Central

America AAA (P151829)

May 2016

Final delivery

December 2016

IMF Work

Program

Staff visit

November, 2016

Regional Conference

November, 2016

Technical assistance:

2016

National Accounts and Price Statistics

Monetary and FX Operations

Banking Supervision and Regulation

Fiscal Revenue and Expenditure

Management

7. The attached table summarizes the financial relations between Costa Rica and the
World Bank (in million U.S. dollars).

Table 2. Costa Rica and the World Bank: Financial Relations

Project Name

Total loan

through FY16

in FY17

Projected

Undisbursed

disbursements

Higher Education Improvement Project

Catastrophe Deferred Draw Down Option

Strengthening Universal Health Insurance

200

420

171.5

420

8 INTERNATIONAL MONETARY FUND

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COSTA RICA

RELATIONS WITH THE INTER-AMERICAN

DEVELOPMENT BANK

Recent activities. The IBD´s loan portfolio in Costa Rica has 11 sovereign guaranteed

operations in execution and two programs pending ratification, with an approved amount of US$

2.046,18 million. The available amount for disbursements is US$ 1.312,15 million (64% of the

approved), and is concentrated in the areas of Transportation (44,5%), Energy (34,2%), Education

(8,2%) and Reform and Modernization of the State (6,5 %). The average age of the operations is 2.1

years. Disbursements of sovereign guaranteed operations during 2016 are expected to reach around

US$146,9 million, concentrated in the areas of Transportation (27.4%), Energy (26,2%) and Reform

and Modernization of the State (23,8%).

Future plans. During 2016, the IDB expects to implement the 2015-2018 Country Strategy

for Costa Rica, focused on the areas of Infrastructure and Logistics, Innovation and Competitiveness,

Energy, Education and Public Finances. In 2016 the IDB expects to approve two Sovereign Guarantee

loans for a total amount of US$140 million on Integrated urban consolidation and the Cantonal road

network.

Loan Disbursements (Sovereign Guaranteed Operations)

(In millions of U.S. dollars)

Disbursements
Amortization
Interest and charges
Net cash flow

2009 2010 2011 2012 2013 2014 2015 2016*
40,6 55,7 121,0
146.9
55.1
45.1 44.6 46.6
19.7
11.8 11.4 10.3
70.2
-18.2
62

86,9 131,3 209.9 173.4
38.5
44.7 36.2
9.6
12.8
84 165.7 120.4

31.9
10.2

-0.3

9.3
31.0

* Projections (February 2016)

Projects

Lending Program for 2016 (tentative)

(In millions of U.S. dollars)

Integrated Urban Consolidation - Bonos Comunales

Cantonal Road Network Program

Total

Amount

140

INTERNATIONAL MONETARY FUND 9

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COSTA RICA

Sovereign Guaranteed Operations (as of February 29, 2015)

(In millions of U.S. dollars)

Approved

Disbursed Obligated Available

Loans in execution

2.046,2

734,0

146.90 1.312,15

Sustainable Development of the Binational
Watershed Rio Sixaola

9,22

0,0

Tourism Program in Protected Areas

19,0

11,36

7.64

7,64

First Electric Power Sector Development Program
2008-2011

250,0

232,54

17.46

17,46

First Road Infrastructure Program

300,0

286,67

13.32

13,32

Cantonal Road Network Program

60,0

25,86

15.00

34,14

Water and Sanitation Program

73,0

5,07

6.23

67,93

132,4

41,93

35.00

90,51

35,0

9,01

8.50

25,99

250,0

97,23

21.00

152,77

167,52

15,13

10.75

152,39

450

100

200

0,0

12.00

450

0,0

9,7

0,0

100

200

0,0

9,9

Violence Prevention and Social Inclusion
Promotion Program

Innovation and Human Capital for
Competitiveness Program

Power Sector Development Program 2012–16
(Reventazon Hydroelectric Project)

Education Infrastructure Construction and
Equipment Program

Infrastructure Transport Program

Border Integration Program of Costa Rica*

First Renewable Energy, Transmission and
Distribution of Electricity Program*

Nonreimbursable Technical Cooperations

19,6

Total

*Pending ratification

2065,78

743,72

146,9

1322.05

10 INTERNATIONAL MONETARY FUND

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COSTA RICA

STATISTICAL ISSUES

(As of April, 2016)

General: Data provision is broadly adequate for surveillance. The quality of macroeconomic data

has continued to improve in recent years. This was confirmed by a reassessment of the Data Module

Report on the Observance of Standards and Codes (ROSC) that was published in February 2010.

Further statistical improvements are being pursued, including in the real, monetary, fiscal and

balance of payments sectors. The Central Bank, the Ministry of Finance, and the National Institute of

Statistics and Census make data available to the public through regular official publications on their

websites (www.bccr.fi.cr, www.hacienda.go.cr, and www.inec.go.cr).

National accounts: National accounts are compiled generally in accordance with the System of

National Accounts 2008 (SNA 2008). The Central Bank disseminated the annual national accounts

data for the years 2012-2015, with 2012 as the new base year of the system. The full transition

including release of the rebased historical data is scheduled for completion by September 2016.

Estimation of real estate housing including owner-occupied housing has been improved: the

housing stock of the base year (2012) has been estimated at the most detailed level according to

the 2011 Census, at national, provincial, canton and district level. To calculate subsequent years, the

rental item of the CPI is used as the price indicator, and the volume is extrapolated from the

statistics of houses built with residential purposes obtained from the construction industry.

Accounting depreciation is used instead of estimating consumption of fixed capital. In the new

system, double deflation method is applied to obtain annual value added in constant prices;

whereas single extrapolation is used for quarterly volume estimates using output volume indicators.

Appropriate price indices are used to derive current value estimates. Changes in inventories are

obtained following the 2008 SNA recommendations for those products for which enough

information is available. This includes the most important agricultural and livestock products. The

proportional Denton method is applied for benchmarking quarterly national accounts series to their

annual counterpart. The informal activity of households as producers of goods and services is

included in GDP level (but not separately estimated) thanks to the elaboration of employment and

remuneration matrices.

Price statistics: The compilation of the consumer price index (CPI) employs concepts and definitions

from the last international CPI manual. Its structure, scope, and coverage have been recently

updated. The CPI weights are based on the 2012/2013 Income and Expenditure Survey, and the

index covers the national urban and mixed households, which comprise approximately 73 percent of

the total population and 82 percent of the total consumption expenditures of Costa Rica. Atypical

movements in the data are investigated and corrected when necessary.

The PPI is compiled based on concepts and definitions from the 1993 SNA and the international PPI

Manual, and is calculated both by product and economic activity (manufacture and services

activities). The base year of the PPI for domestic manufacture, transportation, tourism services and

INTERNATIONAL MONETARY FUND 11

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COSTA RICA

professional services is 2012, whereas PPI for electricity and sales hydrocarbons, and the export and

import price index (that is not yet available) are calculated following a moving-base approach.

Government Finance Statistics: The concepts and definitions used in compiling GFS generally follow

the guidelines of the GFSM 1986. However, financing data and government debt, which use national

concepts that combine instruments and holders, are not in accordance with international standards.

Monthly fiscal statistics are only compiled and disseminated for budgetary central government,

while annual statistics are compiled and disseminated for the entire public sector and its subsectors.

Annual data for the GFS Yearbook are reported on a regular basis, most recently for 2014. The place

of issue (Costa Rica or abroad) criterion is followed to classify domestic and foreign debt, instead of

the internationally recommended residency criterion. Fiscal data discrepancies among national

compilers on particular items are not regularly reconciled, although large fluctuations or

discrepancies are investigated. Fiscal statistics are not regularly reconciled with monetary statistics,

or other macroeconomic statistics.

Monetary and Financial Statistics: Central Bank of Costa Rica (CBCR) reports the Standardized Report

Forms (SRFs) 1SR for CBCR, 2SR for the other depository corporations (ODCs), and 5SR for monetary

aggregates for publication in the IMF's International Financial Statistics (IFS) on a monthly basis with

a lag of two months. The reported monetary statistics are broadly in line with the methodology of

the Monetary and Financial Statistics Manual (MFSM). The classification of financial instruments and

economic sectors follows the MFSM with some exceptions. Accrued interest is not classified together

with underlying instruments, as recommended the MFSM. The CBCR is working for expanding the

coverage of the monetary statistics including short term funds as ODCs and investment funds and

pension funds as other financial corporations.

Financial sector surveillance: Costa Rica reports all core financial soundness indicators (FSIs) and one

of the 13 encouraged FSIs for deposit takers on a monthly basis for posting on the IMF’s FSI website

with less than one quarter lag. The authorities are planning to expand the reported FSIs of the

encouraged set for deposit takers.

External sector statistics: The Central Bank of Costa Rica (BCCR) compiles and disseminates quarterly

balance of payments and international investment position (IIP) statistics, which are produced on a

sixth edition of the Balance of Payments and International Investment Position Manual (BPM6) basis.

Source data are generally adequate and derived from sound collection programs and work is still

ongoing to improve the coverage of financial transactions of the nonfinancial private sector (such as

those related to trade credit and advances), and remuneration of employees. Transfer prices in some

cases are not converted to market prices.

The BCCR also monthly compiles and disseminates the Data Template on International Reserves and

Foreign Currency Liquidity, reports semi-annual data to the Coordinated Portfolio Investment Survey

(CPIS) and annual data to the Coordinated Direct Investment Survey (CDIS), and submits quarterly

external debt statistics to the Quarterly External Debt Statistics (QEDS) database.

12 INTERNATIONAL MONETARY FUND

Page 85

Data Standards and Quality: Costa Rica is in observance with the Special Data Dissemination

Standards (SDDS). Data Module Report on the Observance of Standards and Codes (ROSC) was

published in February 2010.

COSTA RICA

INTERNATIONAL MONETARY FUND 13

Page 86

C
O
S
T
A
R
C
A

Costa Rica: Table of Common Indicators Required for Surveillance

(As of March 24, 2016)

Date of latest
observation

Date received

Frequency of

Data5

Frequency of
Reporting5

Frequency

Publication

Exchange Rates

Mar 16

International Reserve Assets and Reserve Liabilities of the
Monetary Authorities1

Mar 16

Reserve/Base Money

Broad Money

Feb 16

Central Bank Balance Sheet

Feb 16

Consolidated Balance Sheet of the Banking System

Feb 16

Interest Rates2

Mar 16

Consumer Price Index

Feb 16

Mar 16

Revenue, Expenditure, Balance, and Composition of
Financing3– Central Government

Dec 15

Feb 15

Stocks of Central Government and Central Government-
Guaranteed Debt4

Dec 15

Feb 15

External Current Account Balance

Sep 15

Jan 16

Exports and Imports of Goods and Services

Sep 15

Jan 16

GDP/GNP

Gross External Debt

Sep 15

Jan 16

Sep 15

Jan 16

International Investment Position

Sep 15

Jan 16

Memo Items:

Data Quality –
Methodological

soundness6

Data Quality –
Accuracy and

reliability7

O, LO, LO, LO

O, O, O, LO, O

O, LO, O, O

LO, O, LO, LO,O

LO, LNO, LO, LO

LO, O, O, LO, O

O, LO, O, LO

LO, O, LO, O, LNO

O, LO, LNO, O

LO, O, LNO, O, LO

1 Includes reserve assets pledged or otherwise encumbered as well as net derivative positions.
2 Both market-based and officially-determined, including discounts rates, money market rates, rates on treasury bills, notes, and bonds.
3 Foreign, domestic bank, and domestic nonbank financing.
4 Including currency and maturity composition.
5 Daily (D); weekly (W); monthly (M); quarterly (Q); annually (A); irregular (I); and not available (NA).
6 Reflects the assessment provided in the data ROSC, published in February, 2010 and based on the findings of the mission that took place in April, 2012, for the dataset corresponding to the variable in each row.
The assessment indicates whether international standards concerning concepts and definitions, scope, classification/sectorization, and basis for recording are fully observed (O); largely observed (LO); largely not

observed (LNO); not observed (NO); and not available (NA).
7 Same as footnote 6, except referring to international standards concerning source data, assessment of source data, statistical techniques, assessment and validation of intermediate data and statistical
outputs, and revision studies.

1
4

N
T
E
R
N
A
T
I
O
N
A
L

M
O
N
E
T
A
R
Y

F
U
N
D

Page 87

Statement by Mr. Jimenez Latorre, Executive Director for Costa Rica

and Mr. Pacheco, Senior Advisor to the Executive Director

May 16, 2016

The Costa Rican authorities appreciate the constructive and transparent dialogue with staff and
broadly concur with its assessment and key recommendations.

Economic outlook

Costa Rica has continued growing at an accelerating rate during the last three years. As a small
open economy, the country is exposed to a variety of shocks such as commodity prices volatility,
international financial conditions and main trade partners’ growth, besides its high exposure to
natural disasters. Thanks to an increasingly diverse economy, adverse weather conditions for
main agricultural exports were compensated by dynamic export of services and lower import
commodity prices, especially oil during 2015. Exports supply has widen, medical devices—the
main export product— continued to perform strongly while services grew 8.4 percent in 2015
reaching all-time records driven by tourism, IT, information, medical and other business services.
FDI also grew in 2015 and is expected to continue financing a sustainable current account deficit.
The central bank’s growth projection for 2016 rose to 4.3 percent after closing at 3.7 percent in
2015. The combined effect from improved external demand, stability in main macro variables
and lower interest rates have contributed to accelerate the rate of growth which raised to 5.4
percent y-o-y as of February 2016.1

Overall, the economy is expected to continue growing above 4 percent in the medium term in the
midst of a fiscal consolidation process and propelled by a loose monetary policy stance, if price
pressures do not arise. Even though some risks in the financial sector have build up, the sector
remains sound and resilient and the authorities have put in place a number of measures and stand
ready to take further actions to keep strengthening the financial system and maintaining it in a
growth-friendly development stage.

1 Measured by the monthly index of economic activity (IMAE).

Page 88

Fiscal Policy

The government has put in place many administrative measures and a technological revamp to
improve tax management. The start up of a new virtual tax administration system eased
significantly the administrative cost for taxpayers and digitalized all relevant information to
tighten controls. A special strategy to closely monitor large taxpayers was put in place which,
combined with other efforts, has helped increase the number of income tax files by 21 percent
and income tax revenue by 14.3 percent during 2015. Consequently, the revenue effort climbed
to 13.7 percent of GDP in 2015 from 13.2 percent in 2014.

On the spending side, the government has continued working to reduce the growth rate of the
wage bill and other current outlays. Latest figures show that the Q1 2016 wage bill grew 3.4
percent compared to the same period last year, while the average growth rate on the first quarter
of the last four years was 9.9 percent. In the same vein, purchases of goods and services
decreased 28 percent during the first quarter compared to the same period last year. Even though
it is too early in the year for conclusions, the government is showing its commitment to hold up
current expenditure. In fact, salary increases during the last semesters have been almost
negligible for professional central government servants.

With regard to fiscal reform, the government has sent to congress a comprehensive package of
law initiatives,2 nine law proposals, to address both the revenue and the expenditure sides of the
balance. The broad part of the adjustment is expected to come from the reform to VAT and
income tax which were submitted to Congress last year. In the current VAT setup, services—the
most dynamic sector of the economy—are exempted. Thus, the proposal amends these leaks
while regressivity concerns have been tackled by exonerating the population below the last 4
deciles of the income distribution. The Anti-smuggling law was approved by congress as
expected and it is already under execution.

In the case of the Anti-tax evasion initiative,3 its approval has taken longer than expected because
the government managed to include the foundation of a business ownership registry, including
information of final beneficiaries. This goes in line with OECD, G-20 and G-5 recent initiatives
to allow for future automatic exchange of information. In the meantime, the corporate tax law is
advancing properly in congress; its final approval is expected soon.

On May 1, 2016 a coalition of parties that control congress directorate agreed on promoting a
fiscal reform agenda tilted to the expenditure side. They are proposing to approve a
comprehensive set of expenditure measures before approving VAT and income tax reforms.
Since many of the coalition measures were already contemplated in the government package (see
footnote 2), the authorities have taken this as an opportunity to speed up fiscal reform and
negotiations are currently underway.

2 The package presented by the government is composed by the following law proposals: reforms to the VAT
and income tax, anti-evasion, anti-smuggling (already approved), corporate tax, reforms to improve the treasury
single account, reform to improve public servants evaluation, reforms to control pensions paid out of the budget
and the fiscal rule (to be sent in the next days).

3 This law proposal is intended to strengthen tax controls and enforce collection.

Page 89

Monetary Policy, Exchange Rate Policy and Financial Sector

The central bank has continued working on strengthening its monetary policy framework in order
to have inflation as the undisputable anchor, including the successfully surrender of the XR band
in early 2015. Also, it has succeeded in anchoring inflation expectations, allowing the recent
revision of the inflation target range to 2-4 percent (from 3-5 percent), in line with average
inflation of main trading partners.

So far three particular characteristics of the economy have shaped the current FX intervention
rule aiming at countering deviations from medium-term fundamentals as well as from excessive
volatility. First, the high level of dollarization is making the bank more vigilant of financial
sector vulnerabilities. Second, the FX market lags competition since it is dominated by few large
players. Finally, since the inception of the new XR regime, the FX market has been largely on
surplus which would have induced even larger real exchange rate appreciation in the short run.4
The staff has seen merit on this explanation and the central bank is working on a new set of rules
that would increase competition and deepen the FX market. More XR flexibility and
communication on the intervention policy would flow as these measures are put in place.

The authorities concur with staff that the dollar-denominated credit has been growing faster than
desirable and, as recognized in the report, they have come up with a series of measures to address
this common concern. They already increased capital risk-weightings for dollar denominated
credit to unhedged borrowers and set up a 15 percent reserve requirement to medium- and long-
term new foreign bank borrowing (this requirement on short-term foreign borrowing was already
in place). However, the authorities’ efforts have not stopped there. They are also working on a
new proposal to further increase capital provisions for dollar denominated credit and preparing a
law proposal to allow increases above 15 percent to the reserve requirements on FX bank
borrowing. The authorities are determined to end up this trend and do not rule out additional
measures, if required.

Structural Reforms

The authorities recognize the importance of improving the business climate and competitiveness
overall. Last year relevant reforms were approved on access to credit, easiness to pay taxes and
access to electricity, which allowed the country to gain 21 positions in the 2016 World Bank
Doing Business report.5

4 Even though REER has appreciated recently, as confirmed by staff, there is no evidence that it has deviated
from fundamentals so far.

5 The main reforms were: a new secured transaction law that broadens the kind of assets that could be used as
collateral on financial transactions, the implementation of an electronic filing system for income and sales taxes
and the reduction of the time that takes a business to get electricity.

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In order to address infrastructure gaps, large projects are under execution and many more are in
the pipeline thanks to a wide variety of financing sources. The construction of a mega-port in the
Caribbean coast awarded to the Dutch based, APM Terminals,6 advances as programmed and is
expected to be operational in 2018. A new highway—in the north part of the Inter-American
highway, key for trade and tourism—is almost ready and will come into operation next month.
Major projects to revamp the capital beltway are currently under execution with some sections
projected to open this year. Other key routes, including connections to the new port, will begin
major overhauling next year using already secured funding from China, multilaterals and a novel
figure through bank trusts.7

Costa Rica’s environmental friendly policies are deeply entrenched in the population. Electricity
generation is an example where 97 percent was produced from renewable sources during 2016
first quarter, following the same pattern of 2015. Most of them, 65 percent, came from
hydroelectric power plants, while 16 percent from wind, 14 percent from geothermal and two
percent from biomass. Solar energy represents a fraction but its participation would probably
increase. The system delivers a high quality service and network coverage is very high compared
to regional standards. In line with its ambitious environmental goals a wastewater treatment
plant, financed through Japan’s cooperation agency, was inaugurated last year which would
duplicate the percentage of treated water in the short-run and, as the sewerage network is
developed, it would initially take the water treated percentage up to 27 percent of the population.

The authorities are committed to further strengthening the policy mix to preserve macroeconomic
and financial stability as these are key to maintain Costa Rica’s strong structural features such as
high income per capita, social development and governance indicators, which are also supporting
the process to become an OECD member.

6 APM Terminals is an independent business unit within the Danish-based Maersk Group.

7 There is one project using this financial model already approved by congress. Predefine future tolls would be
securitized to finance the road construction.